Why Do Gold Prices Plummet?

Key Takeaways

1. Gold prices often dip when economies are booming, as investors tend to stick to more traditional investments. They also decline when the US dollar is strong or when interest rates rise.
2. Some macroeconomic events, like changes in central bank policies or the early parts of recessions, can cause the price of gold to drop – though for quite different reasons.
3. Gold price drops can occur suddenly and may not always indicate a long-term trend.

Introduction

Gold prices go up and down on a near-constant basis. It is not uncommon for the price to change 10% in just a month, and its long-term price history reveals many rises and dips that make investments increase or decrease in value by several multiples.

This volatility can make for a wild investor ride. In order to combat the nerves that gold’s swings can provide, it is crucial to understand both why the price of gold rises and, in this case, why it falls.

Factors Influencing Gold Prices

The price of gold is a bit unusual in the fact that various world events, conditions, and situations can affect it significantly. Many of the shifts in price over the years are directly or indirectly attributable to external factors. Generally speaking, these factors fall into one of two categories.

Supply and Demand

Like any other commodity, the value of gold begins with a comparison of the available supply of it against the investor demand for it. The price is the point of agreement between how much suppliers will accept in trade, and how much investors will pay for the metal.

So, changes in either side of the equation can cause major price shifts in gold. Gold must be mined from the earth and refined with specialized equipment before it becomes ready for the market.

On the other side, gold is a key component for the aerospace, medical, and electronic industries due to its elemental properties. Thus, there is constant industrial demand, and any changes to technology or usage in those fields can have a major effect on the demand for gold.

Demand may also increase at a national level due to changes in central bank policy. A central bank has the resources to buy or sell large quantities of gold in a short period, and its demand (or lack thereof) can have a major impact on the price of gold itself.

Economic Conditions

Gold is also notable for its reactions to various economic conditions and situations.

Generally speaking, stock markets and the price of gold tend to vary inversely with one another. As one goes up, the other goes down due to the rush of investors toward the rising investment category.

Investors often turn to gold during periods of high inflation because the value of their investments in fiat currency becomes diluted. Similarly, recessions, bubbles, and depressions tend to cause an increase in gold’s price, since gold is relatively safe from those types of conditions.

On the other hand, growth of an economy generates investor and consumer confidence in more traditional investments like stocks and mutual funds. Thus, gold’s price usually drops during those periods, although it usually treads water during deflationary periods because of the competing pros and cons deflation offers to the economy.

Specific Events That Trigger Gold Price Drops

There are several different events that can cause the price of gold to drop. Some of them make sense, while others may be a bit counterintuitive. Whatever the case, it’s helpful to understand these events and how they have affected gold prices in the past

Economic Crises and Recessions

As a general rule, tough economic times generate higher gold prices. Traditional investments like stocks or IRAs falter, and investors seek out the safe haven provided by gold. now-cheaper gold

However, in the early days of a recession or downturn, an unusual situation may occur. The price of gold may suddenly drop – sometimes significantly.

The drop signals that a sad and rather poignant event is taking place. In an effort to cover losses in their other investments or otherwise stay afloat, current owners of gold sell their holdings to cash or other more liquid assets.

So, whenever an economic crunch breaks, keep an eye out for these brief swoons, which seemingly come out of nowhere amid major price gains. These brief dips sometimes occur unexpectedly and have historically been followed by rebounds—but their timing and duration are difficult to predict.

Strengthening of the U.S. Dollar

The stronger that the US dollar grows, the lower gold prices tend to fall. In other words, the strength of the dollar is inversely related to the price of gold.

The reason behind this phenomenon is fairly straightforward. If the dollar is strong, investors stick to more traditional investments or feel more confident about sticking with the dollar for their transactions and deals.

Consequently, the need to continue investing in gold tends to lessen. With the lower demand, gold prices have no choice but to fall, absent other factors. In a way, this factor bears a kinship with the dip during economic recessions, in that both of them suggest a greater need for liquid cash than solid gold.

Related: How the USD affects the price of gold

Market Speculation and Investor Sentiment

Traders – especially those with the resources to make big plays – have the ability to buy or sell gold in volumes that can materially move the price of gold itself. Similarly, large institutional investors can change their trading philosophies and begin buying or selling gold in great quantities.

So, if one of them suddenly decides to offload gold, the actual supply of gold may increase and cause the price to drop. In all likelihood, these drops will be short-lived, as some market participants may view the lower price as a reentry point, depending on broader trends or market sentiment.

Geopolitical Stability

When there are geopolitical conflicts between nations, the economy becomes quite unstable, and in some cases, investors may worry that the entire system underlying their investments may crash. So, the price of gold goes up as they head for refuge.

Naturally, during those unusual moments of geopolitical stability and world peace, investor optimism grows. Suddenly, the need for so much security falls away, and market participants often shift focus back to equities and other traditional financial instruments during stable periods.

All of that is to say that good times generally bring the price of gold lower. The recovery periods after the Great Recession and COVID-19 proved as much, with prices falling precipitously after reaching new peaks.

Conclusion

Although the price of gold has generally trended upward in recent decades, there have been notable periods when prices declined sharply. A stronger US dollar, economic stability, and even the early phases of recessions can all contribute to downward pressure on gold.

These declines are part of the natural cycle of commodity markets. Fluctuations in gold prices are influenced by a wide range of economic, political, and market-based factors.

Understanding these influences can help provide context for short-term price movements. Like many commodities, gold’s price history reflects both sharp dips and sustained rallies.