Forex Trading Library

What Are The Main Drivers For Gold?

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The dynamics of gold are changing. Traditional investor behavior remains dominant, but technology is updating the way gold prices move at least in the short term.

The changes might be somewhat subtle and have more implications for traders than for investors.

Traditionally, the price of gold moves due to a combination of fairly simple factors: supply, demand, and investor behavior. Gold, as a metal, is relatively rare. And it’s unlikely we will suddenly discover a large reserve of it.

Mining does not supply a significant amount compared to the total gold available each year. So, with supplies virtually consistent, the price of gold is almost entirely determined by demand, which is a function of investor behavior.

Gold, Paper Money, and Portfolio Diversity

The supply of (increasingly digitized) paper money is arbitrarily set by central banks. While they purport to keep currencies stable, that has not always been the case historically.

Inflation can swing wildly depending on many factors, some being outside the control of even the most capable and diligent central banks.

Investors see gold, with a consistent supply, as a hedge against inflation and a store of value.

Humans initially used the metal as currency because its chemical structure meant it didn’t degrade over time. Regardless of what happens in the economy, if you have gold, it will still be there.

Consequently, most investors traditionally buy gold to protect their portfolio from adverse conditions. Be that either spiking inflation, or deterioration of other assets due to market conditions.

Gold prices work in inverse to expectations of market conditions.

The New Kid on the Block

Gold futures have existed for a long time. But access to digital trading of gold over the last several decades has massively increased the number of people who want to trade the precious metal or have it in their portfolio.

We often call these digital trading mechanisms for gold “paper gold”. Holdings in paper gold are 9 times the total amount of gold available in the world.

Now consider that most gold is currently in the form of jewelry, and less than 20% is available for physical trading. As more people join online trading platforms, this disparity will likely increase.

Spot Price vs Real Price

In the end, the price of gold will always depend on its physical value, because physical gold is what matters to investors.

Spot prices might fluctuate in the short term as people adjust their portfolios, however, they return to the underlying value of gold. This is why, for example, the price of gold initially fell at the start of the COVID crisis.

As liquidity dried up, many traders were forced to sell their assets, including gold, to cover their accounts.

But later, when market liquidity was more balanced, the real price of gold reasserted itself, and the price increased.

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