Top 10 Factors Determining Gold Prices

Over time gold has served as a form of currency and as a long term hedge against currency depreciation – in other words as a wealth protector without being subject to some of the drivers that occasionally see enormous fluctuations in other asset values.

Thus it can serve as a wealth preserver, but seldom as a huge investment gainer except perhaps in the case where the currency it is being held as protection against collapses. Given that growth in annual gold supply is extremely limited in terms of the overall amount held globally, it is seen as carrying little or no counterparty risk, unlike many other popular asset classes.

Given that gold is priced in US dollars, despite being in demand globally, the US markets probably have a disproportionate influence on the overall dollar gold price. Even though the status of many global economies should impact the world gold price, at the moment the state of the US economy tends to take pride of place in determining global gold price movement, although from time to time other factors do play a part.

For example, a few years ago the huge apparent gold flows from western economies to eastern ones was seen very much as a defining factor in gold price strength – in particular Chinese and Indian demand levels were seen as a major contributory element, but this was perhaps just a key component of the global supply/demand balance.

More recently though it would appear that US Federal Reserve policy, and any assumed, or “guesstimated” changes therein, are the most important global gold price determinants.

The price tends to fluctuate up and down on the media and analysts’ interpretations of usually fairly obscure, and often ambiguous, statements from key Fed officials.

Here are 10 key price drivers that can affect current gold prices:

  1. U.S. Federal Reserve (and other major Central Bank) announced, or interpreted, policy initiatives.
  2. Inflation rate assumptions
  3. Day-to-day US data releases
  4. Gold ETF inflows and outflows
  5. Supply/demand fundamentals
  6. US dollar strength or weakness
  7. Investment perception (Animal Spirits)
  8. Central Bank purchases/sales
  9. Asian demand trends
  10. Black Swan events

Perhaps these require a little further explanation. I have placed them in what I consider to be the most relevant order at present.

1. and 2. are somewhat interconnected. Many consider gold to be something of an inflation hedge, but see inflation rates as potentially controllable by Central Bank interest rate policies. Central Bank accommodative quantitative easing policies, and the continuation, or cessation of these, and the likely timing thereof, also come into the equation.

The U.S. Federal Reserve, with its regular Federal Open Market Committee (FOMC) meetings, tends to be the highest profile of these and thus their interpreted outcomes can have an undue influence on the gold price. European Central Bank (ECB) statements can also be important here, but tend to have less impact globally. It should be recognized though that the Central Banks tend to be reluctant to raise interest rates substantially for fear of derailing such economic growth there may be, although if inflation is seen as getting out of hand, this could be a policy restriction they may begin to ignore.

In late August there is an even more relevant U.S. meeting held – the annual Jackson Hole Symposium – which also involves the participation of many other global Central Bank heads. Policy pronouncements and agreements made there may thus have a particularly significant impact on global gold prices going forward.

3. US data releases. Increasingly we have been seeing both positive and/or negative effects from regular releases of specific US economic data and we suspect this will continue as far as short term gold price movements are concerned. In particular the markets tend to react one way or the other to releases on unemployment, inflation and industrial perception.

4. Gold ETF flows – These can have a particularly strong influence on the gold price. Most gold investors will remember back to 2012-14, for example, when there were massive outflows from the global gold ETF sector and the metal price plunged accordingly.

Over 3,600 tonnes (metric tons) of gold are currently held in global gold-backed ETFs, roughly equivalent to current annual global new gold production, so inflow and outflow levels from this sector can be hugely significant. Periods of outflow tend to result in lower gold prices as we have been seeing recently in H2 2020 and Q1 this year. Gold ETF levels do appear to have stabilized in Q2 this year, and we have seen a more consistent, and slightly higher, gold price since as a result.

5. Gold supply/demand fundamentals. Gold supply and demand fundamentals will have another impact on the price going forward. There has been much talk of peak gold already being reached and it is generally recognized that global new mined gold output is at, or close to, its peak. There have been cutbacks in gold exploration, new project development and bank funding to support major new mine developments over the past few years.

Thus we are already seeing a definite slowdown to close to zero in annual gold production increases to counteract a decline in mine output due to falling grades and aging mines running out of ore. With a significant-sized new gold mine probably taking upwards of at least 10 years to permit and bring into production, this situation is unlikely to change in the foreseeable future even if the gold price advances sufficiently to stimulate enhanced exploration activity.

The other principal component of gold supply is recycled gold, which tends to increase if the metal price rises. However it should be recognized that a large proportion of the readily available gold prone to such recycling may well have been liquidated back in the early 2010s.

6. US dollar strength/weakness. Generally the price of gold is inversely related to a stronger US dollar, and vice versa – in other words a stronger gold price is usually seen as a devaluation of the dollar. Dollar strength is hard to predict at the moment as much depends on the US’s economic recovery from the COVID-19 pandemic, and recent statistics are not very promising. If the Fed stays dovish on interest rate rises, as it says it is going to be, the dollar may even slip a little – the consensus view of analysts currently -which would be gold price positive.

7. Investor perspective (or Animal Spirits). The latter was a term coined by economist John Maynard Keynes to describe the psychological and emotional factors that drive investors to take action when faced with high levels of volatility in the capital markets. The term comes from the Latin spiritus animalis, which means “the breath that awakens the human mind,” according to Investopedia.

This could probably also be described as investor greed in the light of such market volatility due to an assumption that the only way for gold is upwards. This has been fueled in part by what this writer sees as over-optimistic predictions of a potential gold price rises by some commentators.

Item 8. Central Bank Purchases/Sales. The levels of Central Bank gold purchases or sales will also have an impact on the gold price. Since the end of 2008 Central Banks have been net buyers of gold annually, which adds to effective demand (or reduces supply, whichever way you want to quantify this). Annual volumes purchased have ranged from a little over 650 tonnes in 2015 down to slightly more than 300 tonnes last year. There have been some additional significant purchases this year which already brings the total in excess of last year’s figure which bodes well for the full year total.

In addition to what appear to be regular central bank purchasers like India, Kazakhstan and Uzbekistan, these significant additions to reserves have been reported by Hungary (63 tonnes in March), Thailand (90 tonnes across April and May) and most recently Brazil – 41 tonnes in June. Some other countries – notably Poland and Ghana – have also intimated they are planning significant additions to reserves in the future. Given that the recent reported additions were not flagged in advance, one wonders if there are other central banks out there also considering some expansion of their own reserves as some distrust in the US dollar grows given the nation’s current huge debt accumulation.

Results of The World Gold Council’s fourth annual Central Bank survey show that one-fifth of the participating Central Banks are expecting to increase their reserves over the next 12 months. This seems to support the premise that there are likely to be other Central Bank gold purchasers on the horizon.

9. Asian demand trends. It has long been apparent that gold has been flowing substantially into normally stronger hands in Asia and the Middle East. Indeed the particularly heavy flows in the middle of the past decade – notably into mainland China – are seen as bringing the gold price collapse from the massive gold ETF outflows (see item 4. above) under control and leading to something of a price recovery. China and India remain very much the world’s two largest gold consumers, and fluctuations of flows into these two nations, as well as into some other Asian and Middle Eastern economies, can have an important impact on the price of gold.

10. Black Swan events. These are Donald Rumsfeld’s aptly described ‘Unknown unknowns’ – geopolitical or geo-economic events arising out of the blue. In theory gold thrives on uncertainty, although this has not always proved to be the case long term. In an uncertain world as at present, such events, depending on their deemed severity, can have a significant, usually short-term ,effect on the gold spot price, but their influence can also wane rapidly as solutions are found and implemented.

The above are what this writer sees as the principal drivers affecting day-to-day movement in the gold price. Other factors may come into play too. But these tend to be few and far between but if and when they do occur can have a usually short-term impact on price.

by Lawrence Williams

Lawrence Williams

Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.

This article can be viewed on the Rosland US website here.