Since the financial crisis of October 2008, the price of gold has skyrocketed from $800 to $1,230 per ounce today or up a whopping 53%.  For those investors out there, this compares to the S&P 500, up only 10%, for the same period.  So, to get our heads around the recent surge in the price of gold let’s take a look at the history of gold & factors that drive the price.

Gold is Denominated in Dollars
That’s right, before there was the dollar, the main currency was gold.  But, as markets became more sophisticated, there was a greater need for more circulation of currency or liquidity.  Thus, the US dollar came to life and gold became denominated in dollars.  Essentially, the result is that the price of gold is inversely related to the value of the dollar.  In simple terms, this means that as the price of gold goes up, it will take more dollars to buy the same amount of gold, and thus the value of the dollar will go down.

Why has the Price of Gold Increased?
This is a tough question to answer since there is not any one factor that you can attribute to the rise in the price of gold.  But, let’s focus on the most dramatic change of late:  the number of dollars in circulation.  Since the October 2008 financial meltdown, the Federal Reserve Bank has increased the number of dollars in circulation.  They have done this by pumping hundreds of billions of dollars in the form of stimulus packages and the “TARP” given to shore up bank balance sheets.  The result is more dollars chasing the same amount of gold that there was before the influx of liquidity.  What happens?  The dollar loses value & the price of gold increases.

Why Doesn’t Everyone Buy Gold?
The change in money supply, among other factors (i.e. world markets, gold supply), is not always known so investing in gold does have its risks.  But, some investors believe that gold is a great safe-haven during uncertain times, especially when the risks for inflation (i.e. increase in pricing) are high.  Some might say that we are currently living during one of those times.

Valuing Gold
There are many different ways to value gold.  Some investors use technical analysis or analyzing the behavioral changes in the price & volume of gold while others look at more fundamental factors.  The investors focused on the fundamentals may historically back-test the price of gold to the Consumer Price Index & GDP per capita.  For instance, if you look at the price of gold in the 1980s and account for the change in the Consumer Price Index from then until now, the price of gold should be well over $2,000 per ounce.  But, that would be short-sighted as this is only one of the many factors you should be considering when valuing gold.

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