Since the dawn of civilization, precious metals -- especially Gold and Silver -- have been recognized as stores of value and have been used as money for transaction purposes. Even today, in the presence of stocks, bonds and a number of alternate investment options, they are a very popular source of investment. They neither yield dividends nor interest and they don't convey an ownership interest in a firm or stock -- in fact, they actually come with additional storage and safeguarding fees. But still, they are an important component of individual as well as institutional investors’ portfolios. Apart from acting as investment vehicles, gold and silver also have a strong jewelry market and are used for manufacturing purposes in some industries.
Fundamentals
The prices of precious metals, like every other commodity, change in accordance with the law of supply and demand, although there are a number of other factors too. The major source of demand for gold comes from the jewelry market, mainly from India, China and the U.S. As far as industrial applications are concerned, there's more demand for silver than gold. Demand as a source of investment increases during times of economic uncertainty, when precious metals (mostly gold) are viewed as a safe haven by many investors. A number of times in the past, gold has been bought heavily during periods of economic crises, resulting in overcrowded trading and a subsequent correction in price. Supply is limited -- mines produce about 60% of all gold in the market every year -- and the rest comes from recycled gold and central-bank reserves.
Another factor that affects the price of gold is the strength of the U.S. Dollar, which, as it weakens, causes many investors and banks to shed their dollars in exchange for gold. That, of course, leads to a surge in demand and thus, an increase in the price. The strengthening of the dollar has a reverse effect, which leads to a depreciation in price.
In times of political unrest and international tension, gold prices increase as people start to accumulate the metal as a hedge to preserve their wealth. Such behavior is also seen in times of increasing inflation, to which gold and silver have had a strong correlation.
Central Banks’ activities also drive the price of gold. As central banks diversify their reserves away from paper currencies toward gold, its price increases. Quantitative easing and an increased global money supply by central banks also devalues paper currencies, further driving up the price of gold. Also, when real interest rates decrease, precious metals become more attractive to investors and their prices rise.
While these are some major factors that influence the prices of precious metals, there are several others like trading and speculation, increased per-capita income, import duties or taxes, etc., which also have an effect on prices.