The Five Key Drivers Of The Price Of Gold
Gold has been the best performing asset since the start of this year. Year-to-date the price of gold has increased from USD 1074.61 to USD 1279.47. That is a return of over 17%. In this article, I will discuss the five key drivers of the price of gold, and highlight the ones that have been the main contributors to this year’s massive rally in gold.
U.S. Interest Rates
Probably the most important driver of the price of gold is the level of U.S. interest rates. When it comes to purchasing gold as an investment, the investor is faced with the opportunity cost of gold being a non-interest bearing asset. Hence, the higher the interest rates are that you receive for holding USD or investing in U.S. Treasuries, the higher the opportunity cost of holding gold. Therefore, the lower the U.S. benchmark interest rate, the more likely you will see a rally in the price of gold. This has been a key factor that has contributed to this year’s rally in gold. The Federal Reserve has pushed back a second rate hike, after the hike in December 2015, which in turn has led to an increase in demand for gold.
The Level Of The U.S. Dollar
As gold is traditionally priced in USD per fine ounce, the price of gold is negatively correlated to the strength of the USD. This is because the weaker the USD becomes, the cheaper it gets to purchase gold. Hence, a continuing strengthening of the USD tends to weaken the price of gold, while a weakening in the USD tends to boost the price of gold. The USD has been trending weaker since the start of 2016. This, in turn, has helped boost the price of gold.
Another key driver of the price of gold is inflation expectations. Gold is widely considered by investors to be a hedge against inflation. Hence, any sign of a pickup in inflationary pressures will tend to push up the price of gold. This is another reason why gold has rallied so strongly in 2016, as inflation is slowly creeping back into the limelight for financial investors.
The Price Of Crude Oil
Historically, the price of gold has had a positive correlation with the price of crude oil. The reason for this is that gold can be used a hedge against oil-driven inflation, and as I have already mentioned, gold is a very popular asset for hedging inflation. Furthermore, a rally in oil prices tends to boost commodities in general, and gold is very popular among the list of trading assets in the commodity space. Hence, a rally in oil will often also lead to an increase in the price of gold.
Gold is considered to be a safe haven asset during times of turmoil. Hence, whenever there is severe geopolitical turmoil, which in turn causes fear amongst investors, the price of gold usually rallies, as investors are seeking safe haven assets to put their capital into. Historical examples of this would be when gold hit USD 850 during the Soviet Union’s invasion of Afghanistan in 1980 or when gold hit its all-time high of USD 1,920 in 2011 as the Arab Spring lead to civil war in the Middle East.
The civil war in Syria, political tensions between Saudi Arabia and Iran, elections in the United States and Russia’s occupation of Eastern Ukraine have all contributed to uncertainty in the financial markets in 2016, which in turn has increased global demand for gold.