The price of gold is one of the main indicators to follow when operating in the financial markets. Gold is the safe haven asset par excellence, so the trend of its price is a very important signal of the perception that investors have of the general economic situation. In addition, gold has an important correlation with some currencies, so monitoring the trend of its price provides information to the market.
And, in turn, gold itself is a commodity that is traded on the markets, so monitoring its price and analyzing it is a must for traders who take positions on gold. But what influences the price of gold in the current market conditions? In this article, we will try to understand in a simple way what drives the price of gold and who is responsible for its variation.
Inflation
One of the main reasons that often lead to the purchase of gold is to hedge against inflation and currency devaluation. Currency values fluctuate, but the value of gold can remain more stable over the long term. Because gold has a value outside of politics and is valued worldwide, gold is attractive as a solid, low-risk investment in the midst of struggling economies. Investors may be encouraged to buy gold when they believe the value of their paper currency is likely to decline.
The value of the US dollar
The U.S. dollar remains the world's dominant reserve currency, and is therefore one of the most widely used currencies by countries for international trade. The price of gold and the strength of the dollar have a crucial and inversely proportional relationship. This relationship is closely followed by investors around the world, as it provides important indications of how gold is behaving against the most widely held currency. The performance of the XAU / USD can influence investment decisions, as an increase in the value of gold could suggest a decrease in the purchasing power of the dollar, prompting investors to turn to gold as a form of protection against inflation risk.
The law of supply and demand
Gold is a raw material that, unlike other raw materials, is not consumed. Although gold has some industrial applications in technological products, the industrial demand for gold is very small compared to its overall demand. In fact, the average annual demand for gold is about 400-500 tons per year. The main component of the demand for gold is the production of bars and coins that serve as a store of value. This demand is much more important than the amount of gold used in the jewelry industry. In fact, given the role of gold as a store of value, one of the main drivers of gold demand is represented by the central banks themselves, which hold part of their reserves in the form of gold. In a context of currency depreciation, Central Bank purchases increase, causing the price of gold to rise.
The price of gold and interest rates
The interest rate in the stock market influences the price of gold, although it is not a direct relationship (since gold is not correlated with the interest rate). When interest rates rise, investors seek liquidity and sell gold to look for other investments that provide them with a short-term return. On the other hand, if the interest rate falls, gold offers lower investment costs and the interest on gold will increase, causing its price to rise as well.
Gold production
About 2.500 to 3.000 tons of gold are produced each year, but the annual volume of physical gold trade is estimated at 165.000 tons. While new production may seem modest compared to the total supply, production costs can affect the cost of all gold in the world. When production costs rise, miners sell gold at a higher price to preserve their profits, and these higher costs are also reflected when it comes time to sell the coins.
Central bank reserves
Central banks hold large reserves of gold and paper money. Specifically, the United States and several European countries hold most of their reserves in gold and have recently been buying more. When central banks start buying more gold than they sell, gold prices rise. This is because the supply of foreign currency increases and available gold becomes scarce.
The jewelry sector and industrial applications of gold
Gold is mainly used in the jewelry sector. If this market is growing, the demand for gold also increases and, consequently, the price rises. The jewelry sector also depends on several factors. In any case, when the demand for products increases, it means that society enjoys greater purchasing power and the price of gold benefits. In addition, new technologies also include gold among their components. The exponential increase in these products is reflected in a greater demand for this material and its price strengthens.
Global crisis
Last but not least, world events also often have an impact on the price of gold as it is seen as a source of safety in the midst of economic or geopolitical turmoil. For example, Gold prices soared immediately after the Russians entered Ukraine, when people have become unsure about the geopolitical stability of the region. In other cases, military action can actually increase general reassurance about geopolitical situations. In fact, the price of gold softened at the start of the first Gulf War. Ultimately, political chaos equates to increased interest in gold as a safe haven.
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