What Drives the Gold Rate?
Gold has seen much evolution since its days as a precious metal for jewelry and store of value. Today, it is one of the most sought-after investment options. On the other hand, gold is a vital component in the manufacture of medical and electronic equipment.
After the fixed pricing of gold was abandoned in the early 1970s, the price of gold has witnessed an increase like none other. From a modest USD 100 per ounce 50 years back, the gold rate scaled to the levels of above USD 2000 in August 2020.
So, what is driving gold prices in today’s world? Its uses are too many and too complex that it is not just a simple case of demand and supply.
This article explores the four main factors that influence the price of gold – 1. Demand from industries and individuals 2. National emergencies such as war and economic crisis 3. Central banks and 4. Investors and Speculators.
1. Demand from Industries and Individuals
According to the World Gold Council data, today, jewelry accounts for about half of the world’s gold demand, which comes to approximately 4400 tonnes. India, China, and the US are the major consumers of gold for jewelry by volume, with India alone accounting for about 25% of it. Gold carries religious significance in the country’s culture and is regarded as an auspicious symbol, a store of value, a mark of status.
Technological and industrial uses of gold account for another 7.5% of the demand. Gold has a prominent role to play in the manufacture of medical equipment like stents and pacemakers and precision electronic devices like GPS units, cell phones, and television. Its malleability, resistance to bacteria, and opacity in X-rays make gold a viable material in the medical field. Electronic devices exploit gold’s high conductivity and resistance to corrosion.
As the world population grows, the demand for gold for industrial and personal use follows suit. Growing industrialization in emerging markets like China, India, and Brazil is also driving up gold demand. With China removing restrictions on possession of gold for its citizens and the purchasing power of citizens rising in these emerging economies, demand for gold is skyrocketing.
2. National emergencies such as war and economic crisis.
Gold is considered a ‘safe haven’ during turbulent times. National emergencies such as war and natural disasters, hyperinflation, and political instability force citizens to use gold as a hedge to protect their assets. The world witnessed major threats of war during the late 1970s, early 1990s, and after 9/11. Gold prices have gone up on every occasion. Though when the nation is at war, people are less willing to invest, focussing more on survival, demand for gold remains high, driving up its prices.
At times of political and economic instability, gold is viewed as a safe investment and stable substitute for national currencies. Hyperinflation in Germany in the 1920s and Zimbabwe during 2008 also led to a spike in the gold demand and consequently the rates. Nations under dictatorship have witnessed extreme measures like a limitation in the export of gold, nationalization of gold mines, and sudden disappearance of gold reserves from their central banks. All these boost demands for gold and its rates. During the global health crisis and pandemics like Covid-19, gold prices surged to unprecedented levels.
3. Central Banks
Central banks of nations with large gold reserves can influence the world gold rate with large scale buying or selling of the precious metal. They do this for a variety of reasons. Large mining companies too can change the gold rate by scaling up or down their production capacities.
While major mining companies have a direct influence on the world gold prices, the role of central banks is no lesser. However, safeguards have been put in place to prevent drastic measures by central banks. The Washington Agreement on Gold (WAG) of 1999 is a move in that direction. This agreement places a limit of 500 tonnes annually on the sale of gold by its signatory nations – United States, Japan, Europe, Australia, Bank of International Settlements, and the International Monetary Fund. Besides this, the central banks account only for about 16% of the existing world’s mined gold. This means that though they can sway gold prices, their influence is limited.
In addition to buying/selling of gold, there is another way that central banks can drive the gold rate. When central banks increase the interest rates for deposits, they are indirectly influencing the demand for gold. Gold as an investment instrument becomes less attractive, thus bringing down the demand and the rate. The reverse is also true. When the central backs bring down the interest rates, investors tend to move away from national currencies and bonds and the clamor for gold goes up.
4. Investors and Speculators
The buying and selling of gold are not limited to central banks to manage national economies. Investors play a huge role in driving the gold rate by putting their money in gold. Investing in gold as a hedge against inflation is one of the oldest reasons for buying gold. The gold rate has a negative correlation with the US Dollar and other currencies. When the value of the dollar and other national currencies become weaker, the demand for gold goes up, driving its price higher.
On the other hand, speculators aim to profit from fluctuations in the gold rate, irrespective of whether the gold prices are rising or falling. While investors aim to reduce the risk factor due to the volatility of the market, speculators thrive on the very same ups and downs. Short-selling is a tactic used by speculators to benefit from the price drop. All these reading activities can drive the price of gold.