What Really Moves the Gold Market?

Zoom out far enough, and the gold chart becomes a steady ascent over thousands of years. But on a shorter time frame, the price is constantly moving up and down.

At the most basic level, these movements can be put down to changing supply and demand.

The supply of gold however is very steady. Even when a new deposit is discovered, it can take over ten years for it to be converted into a productive mine.

So unless a giant golden asteroid falls from space — which some analysts do think is a possibility — then the only force moving the price of gold is changing demand.

Geopolitical events, changes in interest rates, and the price of the dollar are all thought to alter levels of demand for gold, but which of these really makes the price move?

📈 Interest Rates

Ever since the gold standard was abolished, gold has been seen as a form of ‘sound money’ that banks aren’t able to devalue by printing.

But, you’ve heard this story before…

Nevertheless, the story that goldbugs like to tell is true, and one of the biggest determinants of inflation is interest rates.

As interest rates are lowered, more people can borrow more money. This gives consumers more spending money, causing the economy to grow and inflation to increase. With increased inflation, fiat currency becomes less attractive, and demand for gold increases.

This is described in economic terms using words borrowed from the world of birds — gold is said to love doves, and hate hawks.

When the federal reserve takes a dovish stance — meaning that it will be cutting interest rates — gold is thought to move higher.

When the fed takes a hawkish stance — meaning that it will be raising interest rates — gold tends to drop.

This relationship was made very clear at the end of November 2018, when Federal Reserve Chairman Jerome Powell made a speech suggesting that interest rates would be gradually hiked.

In response, two things happened immediately — the US dollar sank and gold soared.

Simple, right?

If only it were so easy…

The truth is that though interest rates do have an impact on the gold price, the relationship is not clear cut — there is no solid correlation between gold prices and interest rates.

Research from the World Gold Council found that only short-term gold movements are ‘heavily influenced by US interest rates’, and there is no strict correlation between the federal funds rate and the price of gold, with upwards movements in the price of gold sometimes being accompanied by rising interest rates.

So while gold traders should still pay attention to interest rates, there are other more powerful correlations to be concerned with.

💲 The Dollar

Most market commentators believe that the price of the US dollar has a bigger impact on gold than interest rates do.

The main reason the value of the dollar influences the price of gold is that its the global reserve currency: The dollar is usually used as the exchange mechanism in international trade, making it the benchmark pricing method for gold.

When the value of the dollar drops, buyers all around the world must pay more dollars to buy gold, And, those buying gold with other world currencies are able to buy more gold with less of their currency.

This results in an inverse correlation, where gold and the dollar move in opposite directions. This relationship is widely accepted, meaning that lots of demand for gold comes from people trying to get exposure to the opposite of movements in the dollar.

In fact, one of the biggest sources of demand for gold is from central banks seeking to minimize exposure to the dollar, which still represents over 60 percent of global bank reserves.

This chart from 2011 to 2018 shows the long-term correlation of the Dollar Index (DXY) with gold.

💣Geopolitical Turmoil

The other common source of demand for gold is from people treating the metal as a safe haven, and buying gold as a form of ‘insurance’ against systemic risk in the financial system.

During times of political and economic turmoil, demand for gold is thought to increase. And during times of high confidence, demand for gold is thought to decrease.

But in reality, how gold reacts to political and economic turmoil is unpredictable. On the day of the worst US stock market crash ever — Black Monday, October 1987 — gold sank with equities as investors panicked and liquidated all their holdings, and in the financial crisis of 2008, gold again crashed with equities before eventually rising again in 2009.

More recently, gold has reclaimed its safe haven title and has been pushing up on political turmoil as concerns over Brexit, the ongoing trade war, and tensions with Iran have brewed.

🐋The Real Force Behind Gold

Though these factors — the dollar, geopolitical turmoil, and interest rates —all have a role to play in moving the gold market, they don’t always make an impact on price.

The only common theme behind all big movements in the price of gold is the presence of institutional money — the ‘whales’ in crypto parlance, and the big banks with very deep pockets.

This has been made apparent in the last year or so, with banks adding around 651.5 tonnes — worth around $27.7 billion — to their vaults in 2018 before a major move upwards.

These big players set the tone of the reaction to economic events, driving both short-term undulations and long-term trends in gold.