What drives the Gold price?

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Our market analyst, Richard Perry, has created an informative document on Gold and what drives its price! This is a research and analysis document that you can refer to time and time again.

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For as long as it retains its shimmer, gold will be a key attraction for investors around the world. Despite arguably having a more dedicated following than any other single investment, this does not guarantee the success of gold as part of a portfolio.
As with any investment, and as the disclaimers warn us, price scan go down as well as up. So, what makes the price of gold move? What drives the gold price?

We will take a look at the key aspects of gold traders need to consider from both a long (buying) or short (selling) perspective. We will highlight the various demand and supply dynamics for the yellow metal, whilst also concentrating on key macroeconomic factors.

Gold performance over the years

The chart in Figure 1 shows how the gold price has fluctuated over the past 56 years.
It is interesting to see that the all-time traded high for gold was posted in September 2011 at $1920, however on an inflation-adjusted basis; the all-time high was $2584 in January 1980 as global inflation peaked while the market traded price of gold was just $850.

What drives the Gold price?

Figure 1 – Chart showing the gold price as at mid-2016 and the inflation adjusted price of gold


What are the key drivers?
There are several key factors we need to consider when looking at how and why the price of gold moves. Aside from intraday trading factors driven by classic technical analysis, there is a raft of fundamental macro-economic factors to consider.

We will look at:

  • Real interest rates
  • Central bank monetary debasement
  • The correlation of gold to the US dollar
  • Gold as a safe haven
  • Risk-on/Risk-off trading
  • Gold as an inflation hedge and how gold trades in an inflation/deflation environment
  • The physical dynamics of gold demand and supply


Real interest rates
The level of real interest rates is generally seen as one of the most important (if not the most important) drivers of the gold price over the medium to longer term. There seems to be a very strong negative correlation between gold and real interest rates. An article “The Golden Dilemma” by Erb & Harvey from the National Bureau of Economic Research in 2013 showed the correlation between gold and real interest rates between 1997 and 2012 as -0.82.

As a basic definition, the level of real interest rates is determined by taking the nominal interest rate (as set by the central bank) and subtracting the level of inflation. If the nominal interest rate is 3.0% and inflation is 2.0% then the real interest rate is at 1.0%. So when inflation rises above nominal interest rates, real interest rates turn negative.
In effect the value of money is falling. Gold will perform well during period of negative real interest rates.

Gold is a zero yielding asset and so the opportunity cost of holding gold is much higher when real interest rates are positive. Therefore, the performance of gold will deteriorate relative to higher yielding assets when real interest rates are positive. This is because it is generally seen as a positive risk environment, with little reason to hold an asset that yields nothing, such as gold.

The chart in Figure 2 from the Federal Reserve Bank of St Louis shows the comparison of the 2015 movements in US real interest rates (as measured by the 10 year Treasury Inflation-Indexed Security) with the price of gold. The chart shows the price of gold decreasing as real interest rates increase.

What drives the Gold price?

Figure 2 – US real interest rates and the price of gold.

Source: Federal Reserve Bank of St Louis

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