THREE FACTORS THAT INFLUENCE THE PRICE OF GOLD

6 August 2024

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THESE FACTORS INFLUENCE THE PRICE OF GOLD

This article looks at the factors influencing the price of gold and applies this to the current situation of major turmoil in the market.

A. Factors influencing the price of gold

According to Ramin Nakisa of PensionCraft, three main factors influence the price of gold:

1. Real Interest Rates

   - Explanation: Gold prices are inversely related to real interest rates. When real interest rates (interest rates adjusted for inflation) are low or negative, the opportunity cost of holding gold decreases, making it more attractive to investors.

   - Impact: Lower real interest rates increase the price of gold, while higher real interest rates tend to decrease it.

2. Inflation

   - Explanation: Gold is often considered a hedge against inflation. When inflation rates rise, the purchasing power of currency decreases, and investors turn to gold to preserve value.

   - Impact: Rising inflation typically drives gold prices higher as investors seek to protect their wealth.

3. US Dollar Strength

   - Explanation: Gold is typically priced in US dollars, so there is an inverse relationship between the value of the dollar and the price of gold. When the US dollar weakens, gold becomes cheaper for investors holding other currencies, increasing demand.

   - Impact: A weaker US dollar generally leads to higher gold prices, while a stronger dollar tends to lower gold prices.

These factors collectively influence gold prices by affecting investor behavior, the perceived value of gold as a safe haven, and its attractiveness relative to other assets.

B. Price of gold in today's market turmoil

Let's see how the above plays out in the real world.

1. Summary of Gold's Recent Performance

• All-Time Highs: Gold reached new all-time highs by the end of the week, 16 August 2024.

2. Potential Drivers of Gold Prices

• Multiple Factors: Gold prices are influenced by various drivers, with the three sighted above as the main factors, including:
  • Fed's Balance Sheet Size
  • Monetary Policy
  • Geopolitical Risk
  • Momentum
  • Inflation
• Current Focus: The weaker dollar is likely the main driver for the recent increase in gold prices.

3. Dollar Influence

• Weaker Dollar: As the dollar weakened, particularly with the euro rising above 1.1, gold tracked this movement and went higher.
• Interest Rate Cuts: The market expects significant rate cuts by the Fed, leading to a smaller interest rate differential between the US and other countries, contributing to the weaker dollar and higher gold prices.

4. Geopolitical Factors

• Middle East and Eastern Europe: Ongoing conflicts might have some impact, recent understandings suggest an increase in geopolitical risks, although many believe potential negotiations to de-escalate tensions will succeed. A major war will drive gold higher, driving risk off behaviour across all markets.
• Insider Knowledge: There’s a possibility that certain market participants might act on insider information regarding geopolitics and this might be the case here.

5. Monetary Policy and Central Bank Activity

• Global Rate Cutting Cycle: We are in a global rate cutting cycle, which generally supports higher gold prices due to easier monetary conditions.
• Central Bank Buying: Recent data suggest that major buyers like China have not been active in the gold market, so this surge may not be driven by central bank purchases.

6. Market Sentiment and Momentum

• Trend Followers: Markets like gold are influenced by trend-following strategies, where momentum can lead to further buying and push prices higher.
• Economic Policies: Some speculate that market reactions to Vice President Harris’s economic proposals, which could lead to stagflation, might influence gold prices, though this seems unlikely.

7. Outlook on Gold

• Positive Long-Term View: Despite potential volatility, there is a positive long-term outlook on gold, with the weaker dollar being a significant factor to watch.

This summary highlights the complexity of factors influencing gold prices, with a particular emphasis on the role of a weaker dollar in the recent surge.