What Drives Gold Prices Higher or Lower?
Tuesday, 9/17/2024 13:01
Gold demand drives prices. Or rates. Or inflation. Or...
GOLD PRICES just keep on going up to hit new all-time highs,
says Adrian Ash at BullionVault.
So whether you're a seller...
...hoping that the
US Fed kick-starts its rate-cutting cycle with a half-point reduction this Wednesday...
...or a would-be buyer, wondering if you'll ever see prices go down below today's level once the Fed starts cutting...
...it's worth asking again:
What drives gold prices higher or lower? Why does the stuff go up or down?
Step forward big gold-owner the Banque de France with
a new research paper:
"The
price of gold is mainly determined by fluctuations in demand."
Simple. But wrong! Very wrong during gold's current surge up to new all-time highs, in fact.
Physical demand in the giant jewellery markets of China and India has gone down, as shown by local prices trading at a discount beneath London bullion quotes, deterring new imports.
Western
gold coin demand collapsed in 2023, and it has stayed down through summer and now autumn 2024 as well.
Gold ETF demand has rallied from the past 2 years' slump, but only really for US-listed trusts...
...and very possibly because the No.1 fund, the SPDR Gold Trust (NYSEArca: GLD), has seen
a surge of speculative gold betting in GLD options contracts.
Those bullish bets that gold is going to continue going up will force banks and brokerages to buy GLD shares, covering their exposure from taking the other side of their clients' wagers. That will lead the GLD to issue more shares, needing more bullion to back them. And since the start of July – as bullion and gold ETF prices have accelerated amid a surge of bullish betting on gold-related derivatives – the GLD has accounted for 84% of net inflows to North American
gold ETFs.
That's sharply greater than the fund's underlying position within that group, where it accounts for 54% by size. GLD inflows are also running sharply ahead of their global weighting, accounting for a massive 42% of gold ETF growth worldwide over the past 11 weeks while accounting for only 27% of the sector's size overall.
As for BullionVault...
...the world's largest marketplace for private investors to trade and own securely stored precious metals...
...users continue to
take profit net-net, seizing on gold's latest record-high prices to bank some or more of their gains and edge down the quantity of gold they own in specialist vaults in London, New York, Singapore, Toronto and Zurich.
And why not? The value of those holdings, after all, keeps going up to new records, now rising above $3.6 billion thanks to gold's bull market.
This isn't new however. Gold buying across the world often retreats in the face of rising gold prices. You can see this clearly on the very best data available, so long as you exclude
the 'OTC' figure which not only covers 'unreported' (and ultimately unknowable) transactions in the global market for large vaulted bars but which also plugs any gap between visible demand and supply from mining and scrap recycling.
That leaves you looking at jewellery demand, coins and small bars, technological use, and central bank buying or selling overall. This chart uses
estimates published by the mining industry's World Gold Council. For
central-bank holdings and demand those estimates repeatedly outweigh the official data reported by central bank reserve managers in public.
As you can see, gold demand overall has plainly moved down as prices move up during the big surge of 2024 to date. That split was more remarkable still during the Covid Crisis starting a little under 5 years ago.
So, Banque de France, want to try again?
"The price of gold," says the French central bank, taking another stab at identifying gold's price drivers in its new report, "is a function of US interest rates and inflation...
"...as well as risk aversion."
Okay, now we're getting somewhere.
We'll come back to 'risk aversion' in moment. Because first, gold pays no income or interest. So it becomes less appealing when interest rates rise. Because cash in the bank grows more attractive.
Hence the historic pattern of gold tending to rise in price when the returns to cash in the bank start falling.
In fact, over the past 7 rate-cutting cycles from the US Fed, the price of gold has traded higher 6 months after the Fed's first cut on all but one occasion...
...giving gold owners an average 7.9% gain in Dollar terms, as Atsuko Whitehouse here at BullionVault noted in
Monday's London gold market report.
But further out, what really counts (or so analysts now including the Banque de France agree) is the real rate of interest, after you allow for the pace of inflation.
Why? It's because high interest rates aren't worth much if inflation also runs high. Cash in the bank might in fact be costing you real value!
Gold, in contrast, cannot be inflated in supply (unlike cash or bonds). Nor can it ever go broke (unlike a bank or a borrower). The stuff does so little, remember, that it can't even rust.
In finance speak, this makes gold "a long-duration durable asset" as analysts at US central bank the Federal Reserve's Chicago division called gold a couple of years ago.
And given that gold pays you nothing ("a relatively stable dividend yield"
according to the Chicago Fed, apparently unable to use 1 simple word when 5 confusing words will do) this means that the price of gold "is expected to have a strong inverse relationship with the long-term real interest rate."
Correct! Well, most of the time. Very true in the 1970s and true again across most of the 21st Century to date...
But check out the mid-1980s and 1990s, plus the past couple of years.
Gold instead went in the same direction as real yields on longer-term bonds...
...defying the pattern which analysts and traders would otherwise like to set their watch by.
Between 1984 and the start of the year 2001, the 10-year US Treasury bond yield fell from 7.4% per annum above the pace of inflation to just 1.4% above it.
That made longer-term debt much less attractive to new buyers. Yet instead of giving investors a reason to buy bullion, the real price of gold also fell, dropping (in terms of today's US Dollar) from $1150 per ounce to just $475.
The same thing has happened over the past 2.5 years, only in reverse and much more briefly (so far).
Back in February 2022, the real yield on 10-year US Treasury bonds was minus 6.4%. It shot over 7 percentage points higher to reach plus 1.3% at the end of August 2024. But the real gold price also jumped, rising from an inflation-adjusted $2100 to the current figure of very nearly $2600 per ounce.
What gives?
"Risk aversion," says the Banque de France.
"Generally speaking, risk appetite is negatively correlated with gold" when times are good...
...because "investors favour exposure to risky assets such as equities and corporate bonds over defensive assets like cash, government bonds and gold."
Hence the breakdown in gold's inverse movement against bond yields in the 1980s and '90s. Stock markets were soaring, and real estate too, as the West won the Cold War and peace broke out everywhere that US and other Nato troops landed or bombed.
Hence the breakdown in the past 2 years as well, but in the other direction, with gold rising even as real yields have leapt.
"This appears to have been driven mainly by emerging market central bank buying," says the BdF. The rising gold price has been "justified by investors buying for non-financial reasons, motivated by geopolitical tensions" amid the ongoing Russian invasion of Ukraine...
...the Western sanctions in response...
...and then the Hamas attack on Israel last October, followed by Israel's ongoing bombardment of Gaza...
...plus the growing tensions and risk of region-wide conflict in the South China Sea on top.
But while central-bank gold buying has jumped, this driver of the gold price was already at half-century highs ahead of the Covid pandemic. It also contrasts with the lack of "risk aversion" gold demand among private-sector investors across the last couple of years. Because risk aversion, like gold investment demand outside central banks, has gone missing.
Look, I'm getting almost as tired of showing you this chart as you are of seeing it.
But fact is,
gold and the stock market have rarely been more closely correlated than they are today. And gold isn't alone.
"Exchange-traded funds tracking government debt, corporate credit and equities have now risen in unison for four straight months," says
Fortune magazine, "the
longest stretch of correlated gains since at least 2007."
As for the US stock market itself, the S&P500 index has now gained 25% in the past 12 months. It "has never climbed this much in the run-up to the first interest-rate cut of an easing cycle" says analysis of 7 decades of data compiled by Ned Davis Research and Bloomberg.
"Fed's rate decision will rock markets," says a headline elsewhere.
"Fed rate cuts could boost stocks, or sink them," says another...
...helping investors decide what to do almost as badly as this article about what drives gold prices higher or lower!
Eyes down for Wednesday's Fed decision then. More importantly, watch the updated 'dot plot' forecasts for where the US central bank's policymakers believe growth, inflation and the interest rates they themselves set will head in future.
Because if risk aversion is to return among private investors – boosting their gold demand while emerging-market central banks keep buying too – any hint of economic doubts from the Fed might finally give stock-market bulls reasons to worry that the S&P looks fragile.
Gold, in contrast, doesn't even rust.
Email us