The price of gold moves with a combination of supply and demand, interest rates (and interest rate expectations), and investor risk behavior. This seems simple enough, but the way these factors work together is sometimes a no-brainer. For example, many investors think of gold as a hedge against inflation.
This makes some logical sense, as fiat money loses value as more is printed, while the supply of gold is relatively constant. However, the relationship between gold and inflation is tenuous at best. Interest rates and market volatility in general are better predictors of gold's short-term performance.
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Economists Claude B. Earp, of the National Bureau of Economic Research (NBER), and Campbell Harvey, a professor at Duke University's Fuqua School of Business, price gold in relation to several factors. It turns out that gold does not correlate well with inflation.
That is, when inflation is rising, it does not necessarily mean that gold is a good bet.
This can be best seen by gold's decline during 2022 while inflation was rising at around 7%. (See chart below).
Gold as an asset in a risk/risk position
Depending on market conditions, gold may find some support during economic and market uncertainty. At the same time, gold is a commodity that only has intrinsic value, which means it's worth what the market says it's worth.
This exposes gold as a dead commodity, as when "risk off" sentiment hits the markets, gold may decline along with other commodities, as investors seek to exit their commodity holdings and move to safer ground, for example, United States, Treasurys. It is therefore a fine line between gold benefiting from moderate market volatility (gold up) and gold depreciating during severe market turbulence (gold down), when gold is sold alongside other commodities.
In their paper titled The Gold Dilemma, Earp and Harvey note that gold has positive price elasticity. This basically means that as more people buy gold, the price goes up in line with demand. This also means that there are no fundamental "fundamentals" for the gold price. 2 If investors start flocking to gold, the price goes up, no matter what the economy or monetary policy might be like
supply factors
Unlike oil or coffee, gold is not consumed. Almost all the gold ever mined still exists and more gold is being mined every day. If so, the price of gold is expected to drop over time, since there is more and more of it. So why not?
Aside from the fact that the number of people who might want to buy it continues to increase, the demand for jewelry and investment offers some clues. As Peter Hogg, Kitco's Director of Global Trade puts it, "It ends up in a drawer somewhere." Gold in jewelry is literally taken off the market for years at a time.
Although countries like India and China treat gold as a store of value, the people who buy it there don't trade in it regularly (a few pay for a washing machine by handing over a gold bracelet, for example). Instead, the demand for jewelry tends to rise and fall with the price of gold. When prices are high, the demand for jewelry decreases relative to investor demand
central banks
Hough says that the main drivers of gold prices in the market are mostly central banks. In times when foreign exchange reserves are large and the economy is thriving, the central bank will want to reduce the amount of gold it holds. That's because gold is a dead asset - unlike a bond or even money in a deposit account, it generates no return.
The problem with central banks is that this is exactly when other investors are not interested in gold. Thus, the central bank is always on the wrong side of the trade, even though selling that gold is exactly what the bank is supposed to be doing. As a result, the price of gold falls.
Central banks have tried to manage their gold sales in a cartel-like fashion, to avoid disrupting the market too much. There's something called the Washington Agreement that basically says banks won't sell more than 400 metric tons in a year. It is not binding because it is not a treaty. Rather, it's more of a gentleman's agreement - but one that plays into the hands of central banks, because dumping too much gold on the market at once will negatively impact their investment portfolios.
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