What really drives Gold Prices

Gold - viewed as a valuable commodity has played an important role in portfolio diversification. Let’s look at a few factors that affect gold prices.

1. Central Bank Buying:

Central banks across the world have been net purchasers of gold since the last decade. This buying has particularly intensified in the last two years with 1000+ tonnes of gold being bought by central banks. When big institutions, such as the central banks, buy gold the prices usually tend to stay firm. This is a significant secular trend that has been one of the key drivers of gold and it is staying the course. Few projections suggest - ‘‘^[2]Emerging market central banks could purchase over 600 tons of gold annually until 2030, to take its share in their foreign reserves to 10%. China will likely occupy the lion’s share in global official gold demand.’’

2. Dilution of Paper Currencies:

The significant increase in the global money supply has led to a notable consequence: the gradual decline in the purchasing power of currencies. In essence, as the amount of money circulating in the economy rises, it tends to diminish the value of currencies over time. This phenomenon often results in inflation, which translates to higher costs of living. The simultaneous increase in essential expenses such as groceries, healthcare, and education along with excessive printing of money has led to the devaluation of fiat currencies.

^[4]The chart above shows the United States M2 money supply, which is a measure of all notes and coins that are in circulation against the price of gold. And the trend is clear, as and when money supply has risen, gold prices have followed suit.

In the past, money was backed by gold, which kept it safe from being easily manipulated. Unlike today's paper money, which can be created in large amounts, gold-backed money was limited because it had to be backed by actual gold reserves. Since gold couldn't be made out of nothing, it provided stability to the money system. That's why when paper money loses its value due to too much printing, people turn to gold for safety because it holds its value better.

And, this is very well corroborated with the continuous decline of the US Dollar's purchasing power. The USD has lost ~45% of its purchasing power since 2000 & almost 100% since 1913, that's concerning.

3. U.S National Debt:

^[5]The growing national debt of the United States has played a big role in boosting the price of gold since the early 2000s. The country's debt has skyrocketed from $5.77 trillion in 2000 to $34.3 trillion in 2024, six times its original amount. When a country's debt gets bigger, it raises the chances of problems like economic crises and currency issues. Gold prices have been reflecting these concerns for the past few years.

4. Monetary Policy

The way policy rates are governed around the world has an impact on the prices of gold. For instance, if most of the central banks walk towards the path of rate cuts then it augurs well for an asset class like gold. This is because gold is a non-interest bearing asset, hence if rates are cut, the attractiveness of an interest bearing asset class diminishes, playing in favor of gold. Also, from an inflation hedge perspective, gold tends to see robust demand during rate cuts, as lower interest rate periods usually lead to high inflation.  

Conclusion:

To summarize, as gold is a global commodity, a whole host of fundamental factors both micro and macro come into play that drives its prices. 

Sources:

[1,3,6]: Households Owning Gold, Indian Investor's Gold Investment, Investments in Digital Gold

[2]: Gold Projections

[4,5]: BullionStar Charts (US M2 Money Supply v/s Price of Gold), (Total US Federal Debt)

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Published on Apr 15th 2024