The factors that drive gold prices and why YOU need to know them

Gold is the longest running currency in the history of man. It was first discovered in riverbeds during the Neolithic period 12,000 years ago. It acts as both a commodity (used in jewelry and technology) as well as a currency. Gold was used to support fiat currencies as early as the Byzantine Empire. Gold can also act as a psychological barometer for market sentiment. At the end of the day though the shiny metal is an asset and thus has an intrinsic value. What are some of the factors that can help drive gold prices?

In 1971, President Richard Nixon removed the dollar from the international gold standard. Currencies would no longer be tied to gold prices. The dollar would go on to become the reserve currency for the World. That has made the greenback the benchmark pricing mechanism for gold. When the value of the dollar increases relative to other currencies around the world then the price of gold falls in dollar terms. It is simple economics, there is less demand for gold as it is more expensive in foreign currencies. Gold needs to be discounted for buyers to see more advantageous prices.  Remember 95% of the World’s population live outside the United States and while many have dollar- denominated debt, there is still a substantial number of buyers trying to purchase gold in other currencies.

Here is a chart of the Dollar (Green line) and Gold (Yellow line) dating back to 1995.

The dollar is the key driver and we can see the inverse relationship in the chart. But, at the end of the day, demand and supply are the deciding factors as to people’s desire to own gold no matter what the cost. Some of the key items here include:

  • Geopolitical concerns- Gold has long supported fiat currencies and was the world’s reserve currency until 1971. While the gold standard was in use, countries could not print their currencies ad nauseam as the paper money had to back up an equal amount of gold held in reserves. That is no longer the case and, in times of trouble, we have seen central banks head to the printing presses (now it is the computers) in order to increase money supply to service debt. This lowers the value of the country’s currency and lowers purchasing power. Investors will look to gold during these inflationary times due to its inherent value and limited supply.
  • Gold Production- The supply side will always play a factor in the economics of any asset. Gold mine production was approx. 3,500 tonnes in 2018 which has been relatively flat since 2016. Equipment has advanced but so has the difficulty of mining the metal from the ground. Economic concerns, geopolitical unrest, union strikes can all slow production of gold. The less gold in circulation the higher the prices.
    • An interesting dynamic on the supply side has taken place in 2020. The coronavirus has had an impact on supply as it has cut into the ability to transport gold. Bloomberg data recently had spot gold trading at $1,580 an ounce in March but gold coins were trading at $1,786/oz and 1 oz Gold Bars were trading at $1,729/oz. This divergence shows the impact of a lack of supply on prices.
  • Central Bank Reserves- According to Bloomberg, governments bought a total of 651 tonnes of gold in 2018 (Russia was the biggest buyer). Central Banks buy gold to provide additional security to reserves.
  • Jewelry- The World Gold Council reported that jewelry demand made up half of the 4,400 tonnes of gold demand in 2019.
  • Technology- Approximately 7.5% of gold demand was for technology and industrial use.
  • Investment Vehicles- Exchange Traded Funds need to back positions with gold bullion. The SPDR Gold Fund (GLD) holds 915 tonnes just to back its assets. These investment vehicles represented 25% of gold demand in 2019 according to the World Gold Council.

As we noted, gold is an asset and has intrinsic value. It is backed by the dollar which is the primary driver but there are a lot of variables included with the price action in gold. Understanding these key drivers and being able to spot news headlines that could impact gold are key for any investor in the metal.