What Drives The Price of Gold?

Gold is one of the most sought-after precious metals in the world. However, golds value rises and drops at different intervals because of various reasons. 

So, what are these reasons, and what drives the price of gold?

There’s no specific driver for gold prices. Several factors combine to influence its price. These factors include supply and demand, ETFs, monetary policy, inflation, central bank intervention, currency movements, and gold production.

In this article, I’ll discuss these factors to help you understand why gold prices soar during certain periods and why they decline when you least expect.

Gold Supply and Demand

One primary reason for the shift in the price of gold is supply and demand. This factor plays a significant role in the price of gold, but we often overlook it for some reason.

I’m pretty sure you didn’t even consider it.  Gold has several uses; therefore, it’s almost always in demand. Unfortunately, this precious metal is quite rare.

And like all other products or services, gold prices rise when there’s high demand for it and insufficient supply to meet users’ needs. Conversely, when demand falls below supply, the value of gold declines.

Lower demand is rarely an issue with gold, though.  The jewelry and electronics industries are the most significant users of gold. For example, in 2018, the demand for gold from the Jewelry industry alone was about 2,200 tons (4,400,000 pounds), and the production for that year was 4,490.2 tons (8,980,400 pounds).

The industry takes almost half of the supply, leaving other industries to scramble for what’s left. Thus, gold will always remain in high demand for the foreseeable future.  

Gold Exchange Traded Funds (ETFs)

Exchange-Traded Funds (ETFs) have some impact on gold prices. In the past, ETFs such as iShares Gold Trust only allowed investors to purchase gold without mining stocks.

However, they now buy and sell physical gold, following investor demand. So, as ETFs buy and sell gold in line with investors’ needs, they inadvertently affect the price of gold. 

Monetary Policy

Monetary policy arguably has the most significant influence on gold prices, and the US Federal Reserve’s policy has the most impact on gold prices.

Interest rates greatly influence the price of gold because of “opportunity cost.”  Opportunity cost simply means you trade one guaranteed investment for another because you believe you will profit more from the latter. 

So, when interest-bearing asset returns are low, leading to loss of money, gold becomes a wise investment. While there’s 0% yield from gold, it’s still a better option because there’s no money loss.

Therefore, gold becomes more valuable.  This works both ways because investors will leave gold for interest-bearing assets when interest rates rise, thereby reducing its value.

The Federal Reserve has the power to move gold markets. When the Federal Open Market Committee meets to discuss monetary policy and other matters and decides on a hike in interest rates, the price of gold will most likely reduce.

This is because the investors won’t forgo their interest-bearing assets.  Alternatively, if the committee hints at interest rate cuts, the price of gold will increase because investors will increase exposure to the metal to minimize losses on interest-bearing assets.

Rate of Inflation

Inflation can affect the value of gold. However, inflation isn’t always a guarantee that the price of gold will change, but it’s a possibility.

Inflation occurs when the Federal Reserve decides to increase the money supply. When this happens, the value of money already in circulation reduces, so store-of-value assets, such as gold, become more expensive. 

Likewise, gold prices decline when the reverse is the case, and deflation occurs.

Central Bank Interventions

Central bank plays in the gold market are one of the main factors influencing gold prices. When times are good, the economy is doing well, and foreign exchange reserves are looking healthy, central banks tend to offload some of the gold in their reserves.

Remember, gold doesn’t yield any interest, so it loses some attraction as a store of value in prosperous times. However, during this period, the number of investors seeking to buy gold also declines generally. 

So, with the excess supply, the price of gold drops. Central banks often have to sell their gold in bits to avoid affecting the market.  The Washington Agreement resolved that banks will limit their trading of gold to less than 400 metric tons annually.

While this agreement isn’t binding, central banks generally stick to the deal because putting excess gold on the market instantaneously can affect their portfolios negatively.

Currency Movements

The value of the US dollar is yet another influencer of gold prices, and this is because gold prices are denoted in dollars. When the value of the USD drops, worldwide currencies, and commodities, such as gold, increase in value. 

Conversely, gold prices drop when the US economy is strong, and the dollar’s value rises. This essentially means they have an inverse relationship.

Gold Production Costs

Gold production is an essential factor that affects gold prices. The major producers of gold are Russia, China, Australia, Canada, Indonesia, and the United States.

However, more countries have begun gold mining to keep up with demand.  Unfortunately, gold is rare. Therefore, it’s getting harder to make a profit from mining gold.

Mining companies factor this situation into their pricing, thus gradually increasing the price of gold over time.

Geopolitical Events

A geopolitical crisis can influence the price of gold. In times of political uncertainty, wealthy individuals move some of their assets to gold as a store of value.

This explains why gold prices soared to record levels at the start of the war in Ukraine. It has since tapered off from the highs, but the strong upward movement would not have occurred without an event of such proportions.

Conclusion

Well, there you have it. These are some of the reasons for the fluctuations in gold prices. While one of these factors may push the price of gold up or down temporarily, none of them can solely determine its price.

However, one thing is certain; demand, supply, and the behavior of investors are significant players in the value of this precious metal.