The gold price’s recent drop from recent highs to a multi month low of around has re-ignited attention and the debate around the gold price. There are many reasons why the gold price moves, some are short-term others longer-term. What are the different factors that affect the gold price?
A powerful driver of recent gold price moves has been driven by dare-we-say-it Trump tweeting! Although Trump’s all too familiar tweets have attracted much ridicule, for gold price watchers they are to be taken seriously. As president of the USA, Trump’s policies such as cutting US corporate tax rates has led to increasing corporate profits and therefore economic growth. In turn this increases inflation, leading to rate rises. Rising interest rates, and a Trump Presidency, are a threat to the gold price as we will see below!
Gold becomes very attractive when interest rates are near zero as its lack of yield is less of an issue and because low interest rates is usually a sign of a crisis – leading to investors buying gold! Although the New York Fed has stated it wants to normalise interest rates and is looking for any excuse to do so, the growing US economy gives it the confidence to actually go ahead with steady rate rises. This makes the US dollar attractive, to the detriment of gold, as it yields more in a savings account. It also increases its value versus other currencies, giving investor the double win of capital and yield growth!
Rises in the dollar usually depress the dollar price of gold. If the dollar rises holders of other currencies find that they can buy less gold with yens or euros. This depresses demand for gold as it is priced in dollars. Indeed gold competes with cash and bonds. When bond yields are low, gold is attractive because you don’t loose out on returns on bonds if you hold gold instead. When bond yields rise, the cost of holding gold rises: you are giving up higher returns on bonds. That means that gold prices should fall when yields rise.
Gold has long been loved by European investors who may not have the same gung-ho love of the US dollar. Whilst some investors, such as US fund managers, may reduce their gold holdings due to other assets becoming attractive, European investors will see a lower gold price as a chance to increase exposure to gold as protection in their trading plan. This is partly due to their long-term trust of the yellow metal but also as a hedge against potential geopolitical risk, such as the growing trade war between US and China! They know that a market can go up and down!
When two of the largest trading partners slap increasing tariffs on each other, it has the effect of putting barriers to trade – a guaranteed way of reducing trade. As products become more expensive, people are less likely to part with their dosh which leads to a slow-down in growth and usually a recession. The knock-on effect is that all currencies suffer as every country’s economy slows down. The current US – China posturing has the hallmarks of a trade war and would usually lead to gold rising… if it wasn’t for other factors outweighing the benefits to gold of greater uncertainty.
Different investors have different views as to which is the safest asset. The beauty parade of candidates involves German 10 year Bunds, gold and US 10 year treasuries as having claims to being the safest. An asset which pays no yield versus another which does and is seen as offering a similar amount of safety is at risk of seeing its price drop. With US 10 year Treasury yields near 3% and likely to keep going up, has lead US based investors rotate away from gold into treasuries.
Historically the key reason for buying gold was for inflation protection. The problem with this kind of protection is that if inflation doesn’t materialise your insurance (gold) will lose you money. As a result with little inflation expectation, few will want to own gold. And what doesn’t help is when central banks use quantative easing! So extreme in this approach that the form book goes out of the window for how gold should react to lower inflation expectations but with a general belief that inflation is coming!
There are many factors which affect the gold price. Some factors are expected to move the gold price but don’t due to another factor being more powerful! An example is gold’s current weakness due to the strength of the greenback which cannot go up indefinitely. This does need not detract from its standing as a hedge to the world’s reserve currency. One point is clear: uncertainty usually is good for the gold price.