What Drives the Price of Gold?
Gold is different from almost any other asset because it appeals to both investors and consumers. While investors turn to gold as a long-term savings tool and a diversifier, consumers see gold as a sign of wealth.
There are several factors that can have a varying influence on the price of gold. Let’s take a look at what they are.
Supply and Demand
Since 2001, gold demand has grown on average at 15% per year, driven by factors such as:
· Accessibility to the gold market via technology – both mobile and web
· The emergence of derivative products such as gold ETFs (exchange-traded funds)
· A change in focus from central banks buying gold instead of selling it
· The explosion of the middle class in Asian regions, where Gold is held in the highest regard in the form of both investment and jewellery
· Expansive monetary policy by Central Banks
· Increased geopolitical and political risk
Just like any other commodity, the principle of supply and demand is a major influence on the price of gold:
· When gold demand is high and supplies are low, Gold prices will rise
· When gold demand is low and supplies are high, Gold prices will fall
Gold demand is normally analysed on a yearly basis and then divided into different sectors:
· Jewellery demand
· Technology and Industrial demand
· Central bank demand
· Investment purposes
In terms of demand, historically gold has been dominated by the jewellery industry: in 2002, jewellery businesses accounted for 80% of the market share. By 2015, that had declined to approximately 50%. This was largely due to the popularisation of gold as a means of investment: demand for gold bars, coins, and ETFs surged between 2003 and 2013 which contributed greatly to the high gold prices that were seen at the beginning of the decade. Investment demand has now stabilised at around 40% of the market.
When analysing the trend in jewellery, it’s important to know that the relative decline in demand share would have been much greater if not for China, a country that saw a three-fold increase in demand between 2002 and 2017. This partly absorbed the lower demand from developed economies. The process of wealth accumulation in China and other emerging economies continues to play an important role for Gold on a long-term perspective.
From the end of the Cold War in the early 1990s until the financial crisis of 2008 the prevailing view of academics and policymakers was that the US-led global economic and political system was almost infallible. Globalisation and the spread of global trade in goods and services, greatly increased travel had improved living standards for many. It was thought that this configuration would last indefinitely. The faith in this system was exceptionally high and optimism abounded.
The financial crisis planted, slowly at first, the initial seeds of doubt in this system. Such doubts were twofold. The faith in American led capitalism took a knock, though not a body blow. The US Federal Reserve and Federal Government came to the rescue with unprecedented intervention in the economy with expansive monetary and fiscal policy.
At the same time, China examined policies that showed it wasn’t happy just being a part of a US system, and that it wanted to carve its own path.
Suddenly the system and thus the future didn’t look so certain. Throughout this period gold continued to slowly appreciate in price.
Fast forward to today and the two decades following the Cold War look very benign. No currency wars, or trade wars. Lower inequality, and reasonably civil discourse between political rivals, domestic and internationally. Markets opening up, trade barriers falling. And all under the watchful eye and guidance of US-led international institutions such as the IMF, World Bank and United Nations. This system, born out of the carnage of WWII looked ready to stand the test of time.
And now it is creaking. When there is uncertainty in the global economy Gold is the safe haven to go to.
One of the by-products of the financial crisis was the crossing of the Rubicon of extreme central bank intervention. It’s not a term heard much these days, but “moral hazard” was a huge part of the debate during 2008 and 2009. During these times, traditional capitalists were adamant that bailouts or indirect support for the economy undermined the whole point of capitalism. Those who took risk are either rewarded handsomely or lose. The action by many governments in 2008 and beyond for many went too far. By increasing deficits and borrowing to bail out failing companies, policymakers were crossing a philosophical line.
Capitalism requires failure and for many such policies would inevitably lead to further bailouts and monetary stimulus in the future, further undermining capitalism as the economic system of production.
Ten years later, trillions of new Dollars, Euros, Pounds, Yen, countless asset purchase schemes, ETF buying and negative rates have all acted to increase the money supply but with little inflation to show for it as the central banks desire. Time will tell whether central banks move back to their more traditional role and more traditional policy measures. Yet it is difficult to think how Pandora’s box can be closed again.