Factors That Drive the Price of Gold

Factors That Drive the Price of Gold

Reading Time: 9 Minutes

Gold is a precious metal that has served as currency for several human civilisations since its discovery over four centuries ago. Presently, the metal exhibits several uses, one of which is a store of value in physical form; physical gold usually comes in bullion and jewellery. Gold also has multiple manufacturing uses due to its malleability, durability, and ability to conduct heat and electricity. Demand for the precious metal often increases due to industrial development.

Short-term supply and demand forces are also paramount to the movement of the gold market. Global social, political, and economic developments influence sentiment. Global economic and political instability tends to see a rise in the price of gold as belief in economic institutions lowers. As you can see, the forces that drive the price of gold are varied and intertwined.

 

 

There are various ways of investing in gold beyond the physical commodity. You can engage with the metal through ETFs (Exchange-Traded Funds), through the stock market: mining companies, for example, as well as through CFDs (Contract for Differences) with FP Markets. With the option of employing leverage, CFDs allow investors to speculate on the metal’s underlying price movement without taking ownership of physical gold. In contrast, ETFs allow investors to purchase shares in an investment pool of gold-related funds that are traded on the stock market.

What Drives the Price of Gold?

  • Interest Rates

Gold and interest rates tend to be inversely correlated. This means that when interest rates rise (decline), the price of gold falls (rises).

Higher interest rates can make gold less attractive as it is not an interest-bearing financial instrument. Therefore, it can be argued that investors prefer cash during these times: short-term bonds and savings accounts. The same logic applies to low-interest rates, which tend to cause an increase in the price of gold as interest-bearing instruments become less attractive.

However, it is important to remain aware that investors purchase (sell) gold for many reasons, and the effect of interest rate changes on the yellow metal remains debated.

  • Supply and Demand

Supply and demand are the primary factors causing gold price fluctuations.

Ceteris paribus, the law of demand states that when the price of a good declines, the quantity demanded increases; conversely, when the price increases, the quantity demanded is reduced. The law of supply also states that when the price of a good rises (declines), producers of that said good tend to supply more (less), all other things being equal. Thus, supply is illustrated through an upward-sloping line on a supply and demand diagram.

Equilibrium is where supply and demand intersect; there is an alignment between the quantity of gold supplied and the price.

  • Central Banks

Central banks are major players in the gold market, and their buying and selling activity can affect prices. According to Trading Economics, the United States is the largest holder of gold reserves and holds more than 8,000 tons, followed by Germany, Italy, France, Russia, China, and Switzerland. If some of these countries were to sell their current gold stockpiles, it could put downward pressure on prices.

  • Economic Data

Economic data is registered through scheduled releases, such as job reports, manufacturing production and overall GDP growth. All announcements help provide a snapshot of the economic landscape. These figures influence investors' trading decisions and confidence in the economy. As you may know, gold is often equated to the dollar: XAU/USD. So, a strong US economy, one that pushes USD higher, is usually detrimental to gold’s performance.

You will also acknowledge that gold will usually become active during periods of risk-on and risk-off. The former tends to underpin equities and riskier assets, and weigh on safe-haven assets, such as XAU/USD, while the latter may see the price of gold bid as stocks decline.

  • Uncertainty

In times of global political and economic instability, gold prices tend to rise. For example, during the 2020 coronavirus pandemic, gold reached its highest value ever. Moments of instability and doubt tend to cause gold prices to rise. International conflicts and political instability are other reasons which cause gold price movement. These events go beyond the US. Global conflicts such as the Russia-Ukraine war considerably affected global sentiment. Brexit has also caused a large section of society to doubt the future and act conservatively in their investments, helping the price of gold rise.

Gold is also often viewed as a safe-haven asset that helps diversify a portfolio.

  • Inflation

Inflation also influences gold prices. Recent trends have seen inflation rise to record levels in the US and most of Europe. Gold has tended to rise in price alongside inflation. However, recently it has struggled to keep up with the soaring inflation levels post-pandemic.

Conclusion

As stated, there are a number of factors that drive the price of gold, some of which are not featured here.

Most investors still see gold as a long-term safety blanket that can help protect them from the uncertainties of the global economy and political events. Gold will most likely retain its safe-haven status and a store of value over time and be a viable asset for the future.

 

 

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Source - database | Page ID - 34686

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