Factors Affecting The Gold Price

Gold can be a frustrating investment to own because at its root, it’s a tough asset to value, and a lack of knowledge of where the gold price is headed might put some investors off. In most markets, there are plenty of fundamentals, reports, signals, and data that can be used to get a good feel for the price of the asset. For example even if you owned a chicken, you could calculate the number of eggs it would bring you followed by the meat on the chicken itself, subtract costs, and get a good feel for its value. Same goes for a business, a house, or even other commodities like oil.

Gold is different because today it doesn’t have a practical purpose in business or in the everyday needs of humans. Yet all of this does not mean that gold is a chaotic, unpredictable, and naturally highly volatile asset. Instead, it just means that gold operates by a different set of factors and principles and knowing what these are and what kind of impact they have is key to answering the ever-present question of “are gold prices going up or down?”. We look at some of the major points impacting gold and which economic data points to follow to know which direction the gold price is headed.


Inflation is regarded as the number one top factor affecting the price of gold. We said earlier that gold didn’t have a practical business or personal use, but the one use it does have is a retainer of value and wealth. Therefore it makes sense that in an inflationary environment, where the value of paper currency is falling in regards to what other goods and services can be bought with it, that people should want another form of money (gold) that DOES retain its value.

THe CPI (Consumer Price Index) is a measure tracking the price change in a basket of common household goods, and is intended to give a good feel of how much inflation there is in an economy and impacting the average urban civilian. The CPI or cost of living index in most countries is tightly controlled by governments and might not include key spending areas like food, energy, utilities, education and health – in the attempt to curb concerns about inflation. The PPI (Purchasing Power Index) is a similar tool but from a producer perspective. Regardless of whether you look at the total money supply, benchmarks like CPI/PPI, or just subconsciously track prices when shopping or paying your bills – gold is very likely to correlate directly in the direction where general prices are headed and that also means down when there is deflation.

gold price vs money supply

Interest Rates

Interest rates are another major indicator of where gold prices are likely to go. During times of high interest rates, capital is scarce and in high demand and therefore a large premium is paid (interest) to those willing to lend out their money. This is a tough competitive battle for gold to win with its non-profit yielding nature (unless you’re in the gold leasing business, which private investors are not) and therefore higher interest rates means lower gold price (negative correlation).

The major economic data point to look out for is the federal funds rate released by the FOMC (Federal Open Market Committee) 8 times per year in the United States. This essentially sets a target inter-bank lending rate, which means that it either makes it easier (cheaper) or harder (more expensive) for banks to borrow money from each other. Higher interest rates would mean that if a bank were short on deposits to lend out to people, it wouldn’t that easily be able to just borrow that necessary amount from another bank, and that would make increase the value of capital and consequently the rates of return you get from that capital, and as mentioned earlier, such an environment does not favor gold.

US Economy and the Dollar

One of the major reasons why the US Dollar became the favored reserve currency around the world (~85% of central bank reserves are in dollars) is because during a 40 year stretch (1931-1971), the dollar was the only form of paper money that was backed by gold. President Nixon closed this gold-for-dollars window in 1971, but by then it was too late to do anything about it. Everyone and everything was already too far invested in gold – whether it’s the countries who had massive dollar reserves, or oil which was priced in dollars, and other structural developments that would take much pain to unravel. Besides the US was the world superpower, destined for financial stability, so their paper was still as good as gold to many unsuspecting stakeholders.

So basically the US dollar has taken the place of gold and all its positive qualities, without there being any form of gold in the equation. This naturally means that the US dollar became a substitute for gold, and a cheap one at that if you compare the limitless paper the US government could conjure up vs the real limited availability of gold. But the reason gold was valued in the first place was because of its rarity and lack of counter-party risk, qualities which paper money does not hold.

So in short, gold will go up and down depending on the apparent strength of the US economy and consequently the dollar – they are inversely correlated so when the dollar goes up the gold price goes down. There are several economic indicators to watch out for that tells us of the strength of the US dollar.

Balance of Payments, Balance of Trade: These items look at the amount of money coming in and going out of the country. If a country produces lots of desirable goods, has good investment prospects and sound economy it’s trade balance is likely to be in surplus and its currency will be in high demand as holding it provides lots of attractive possibilities. The opposite would be a deficit and a weakening currency. Occasional deficits are acceptable, especially for a developed country but sustainable periods of bringing in more value than shipping out of the country will lead to currency devaluation. This is what the United States has been dealing with in recent times ($500 billion trade deficit in 2012) and this not only affects the dollar index against against other currencies, but affects the relative value of gold as well.

US Debt: The amount of money owed to other countries in the form of treasury bills can affect the dollar, and consequently the gold price in a number of ways. There is the impact it will have on the credibility of the dollar as a reserve currency worth owning – meaning if the US debt gets too big and unmanageable, then countries will want to own it less in the risk of never seeing that money again. The other impact of debt is on inflation, and we’ve already talked about how that is a type of environment that favors gold. For example if all of America’s creditors and purchasers of its debt decide to cash in that money and decided to buy real goods and assets in the U.S, there will be an awful amount of dollars chasing few real physical items, and the prices will shoot up.

gold price against us debt

Other Macroeconomic Factors: GNP/GDP, unemployment rate, home sales, retail sales, inventory levels, manufacturing index all weigh in on the health of the general economy and give signals as to whether a nation is headed in the right or wrong direction. Good figures in a multitude of these data points suggest the U.S could be in the midst of a recovery which would strengthen the dollar while weakening gold.

World Instability

Any time a major world event happens for example a terrorist attack, some kind of war, or perhaps some type of crisis – this is a time where the safety of gold ownership is preferred and prices usually respond upwards. The current financial system of fiat paper currencies, stock markets, and debt fueled growth can only operate successfully under the premise that things continue without a hitch. However when one of the underlying assumptions of this system starts to break down, it can easily bring down the rest of the system with it, and at this point gold is the main fallback which transcends borders and nationalities and is known to preserve value and trust, even in the most uncertain of times.

Other Investment Alternatives

We mentioned how high interest rates can dissuade investors from owning gold but other alternatives to interest rates and gold exist to make money. Government bonds, commodities, and stock markets are some of the biggest areas. For example, if the Dow Jones Industrial Average keeps going up, investors will want to get a piece of the action and might be tempted to sell their gold to enjoy some of the gains they keep hearing about on the evening news or reading in the morning paper. Of course the investment world is not that simple, but its the general perception and tendencies of the average investor work that way and perception is more important than reality. It would be wise to remember at this point that gold is only valuable as people deem it to be, so temporarily gold prices could go down if other more attractive alternatives exist (even if other factors suggest gold is a wise investment and other investments are in the midst of a bubble). That’s why patience is often key when being a gold investor. Gold moves in similar lines with other commodities while is usually inversely correlated with the US stock market.

gold vs other commodities

Demand for Gold

As our gold demand analysis showed, about 45% of yearly gold demand comes from jewelry, 45% from investment bullion, while 10% comes from industrial demand. If for any reason one of these areas showed a great surge in demand, then gold prices could rise following the natural laws of supply and demand. With China and India providing much of the fresh demand for gold, the economic conditions of these countries as well as any regulations, holidays, taxes that may be present should be closely monitored.

Mining Supply of Gold

In contrast, supply contractions or new findings can also cause a change in the price of gold. Recent gold supply trends show that gold is becoming harder and more expensive to mine, which will have a upward pressure on the price as population growth and demand surpasses any new gold supply.

Central Bank Policy, World Currencies

Central banks around the world naturally have a lot of say and influence on the fate of gold and its use in modern economics. In a perfect world, where governments and thus central banks act 100% on behalf of the people and having a sound economic policy, then the value of gold could severally be marginalized. Yet that’s not how the world has proven to work over the past couple thousand years. If central banks around the world truly enter a currency war, as it looks like we are, then inflation will be rampant and widespread. How much gold central banks decide to keep as reserves also plays a factor – the last several decades had seen central banks unloading their gold but they have become net buyers once again over the past several years. All the factors affecting the US above also affect other economies, and gold will always serve as a great hedge towards poor economics.

Appreciation in currencies of major gold consumers like the Indian Rupee and Chinese Yuan will decrease the gold price for them and increase demand – leading to generally higher prices.

Futures Market, Manipulation

We mentioned in another post how gold prices were determined on the futures market. This form of trading has unfortunately turned gold into a form of speculative commodity that traders can play around with to gain short term profits. Claims of manipulation are rampant, especially with the US government and large banks having big incentives to keep prices low. Regardless of the manipulation that might go on here with the questionable short selling, all the factors mentioned above should win out in the long term and short term price fluctuations should not be taken too seriously.

As we said in the beginning, gold can be a tough investment to value, but the tools are there and the history is there to back it up.

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