We all watched the wild ride of gold and wondered how and why. There are several forces at work affecting the price of gold. What influences gold prices anyway?
Gold price will usually go up when there are negative economic data. Monetary policy such as interest rates will also move gold prices. If interest rates are high in treasuries, people will therefore sell gold and buy treasuries.
Movements in currencies also affect gold, especially the dollar. That is because gold is dollar-denominated (XAUUSD). The price changes in ETF’s plays a role too but are referred to as a smaller influence.
Lastly good old supply vs demand. The World Gold Council estimated in 2016 that while world supply grew by 1% – demand for gold grew by 15%. According to the World Gold Council in 2019 half of all gold demand was for jewelry, and 7.5% was for industrial uses.
Among the industrial uses electronics producers are heavy users. As a result, strong demand for consumer goods like jewelry and technology hardware can cause gold prices to rise. Investment uses for gold accounted for just under 30% of production, about 1,271.7 tons in 2019.
Production of a rare resource affects the price. In 2019, the globe produced 4,400 tons. Gold is mined, mankind already got all the easy gold. To get more gold requires digging deeper at higher risks. So, producers pay more to get less. While several countries mine gold, the big producing countries are China, South Africa, Australia, Russia, Peru, and the US.
Central banks have taken positions in gold since the US left the gold standard in 1971. While much has been made of gold purchases by many of the world’s central banks, those purchases have actually been slowing this year.
In 2010 central banks bought 79.2 tons compared with 667.7 tons in 2019. Between 2011 and 2019 the range ran between 470 tons and 670 tons. It does not appear central banks will divest gold in amounts that would move prices lower.
Some sources believe that China may add to its reserves after the election. Meanwhile, Colombia, Uzbekistan, and the Philippines may contemplate selling. However, the last ten years have witnessed heavier buying, particularly by Russia, Turkey, and Kazakhstan.
Getting back to price movement and economics. When 2020 started, the economy was running fairly well. In mid-March Gold fell below the 200-day moving average. Looking below at the chart below, we see the price of risk assets such as stocks and gold plummeted.
This crash coincides with the start of government-regulated shutdowns related to the COVID-19 pandemic. Then, as uncertainty about economic recovery and the full measure of economic damage from the pandemic was being discussed, gold shot up.
Gold thrives on uncertainty of stocks.
What may seem odd at first glance was the decline in the gold price as the COVID-19 cases grew in Q3 2020. What you are missing is the economic data. Investors seemed drawn to the Manufacturer Purchasing Manager Index aka Manufacturing PMI, and its counterpart the Services PMI.
Before we bore you with the numbers, you’ll recall that 50 is the magic number. A reading in any country below 50 suggests an economic slowdown is coming. A reading above 50 suggests economic expansion. Do not consider one technical indicator as gospel.
We’ve seen high forties but never high 60s, so the typical range is between 50 and 60. November ran at 56.7, up from 53.4 in October. The advance expectation reading was 53. The service sector was even better news 57.7 in November up from 56.9. This was against the expectation of 55.3.
These differences may seem trivial, but they’re not.
The moral of the story is, in developing your investment strategy, do not second guess which bad news the market will key in on.
Some claim that Gold has a negative correlation to stocks. But that doesn’t appear to be true. To help illustrate the relationship between the price of gold and stock market prices, see the chart below. A relationship exists, but not a correlation. In short, there are many times gold will go down while stocks go up, but even looking at a one-year chart we see that there are also times they travel in the same direction.
March was an obvious example.
What is the path ahead?
It depends on a few things, continued economic recovery, how the vaccine works, and what happens in Georgia on January 5th senate runoff election.
- If the vaccine does not work and the economy is locked down, gold prices may well go up.
- If the Democrats win the US Senate in January, and the government goes on an epic spending spree printing money, that may well be seen as inflationary, gold might go up.
Those with their glass full see a more positive look for the economy. We see that the price of gold traded below the 50- and 200-day moving averages. That could be viewed as a negative for the price. The vaccine that many hope will bring the economy back to whatever normal is will negatively affect gold prices.
The chief commodity strategist for Goldman Sachs expects $2,300 in the next year. Bank America sees $3,000 on the horizon. A bullish case for gold. They foresee increased inflation and are concerned for the longevity of the US dollar as a reserve currency.
Gold is valued in dollars. If the dollar drops, gold will rise. If you trade currencies, you know they are traded in pairs. If the dollar drops in value because of inflation, the other will rise. If you trade that market, you could trade the XAU/USD pair. That is the Gold as the primary currency and the USD as the reference currency.
One word of caution: watch the volatility and the spreads.
Where do the tea leaves tell us the price of gold is going? At the moment, the tea is a little cloudy. The upcoming January 5th Senate runoff, as mentioned earlier, could give us some insight.
Keep an eagle eye out for legislation that involves major spending in the long term.