What Drives the Price of Gold?

Gold has been around since the Garden of Eden, put there by God to provide mankind with a means of trade after the Fall.  Something we learn in our Safety Step: Protect Your Future event is that the natural properties of gold perfectly correlate with the needed properties of money.  That’s no coincidence!  But how does gold work now?  Is it valued the same as it was centuries ago?  Well, in a sense, yes, because gold has what we call intrinsic value, which is the value that does not change.  But, the measure of gold’s value has varied in many ways throughout history, and right now its measure is the U.S. dollar.

Supply & Demand

Just as with anything being traded within today’s markets, the price of gold can be affected by its supply and demand.  There are a couple of things to consider when taking the supply of gold into account:

1.                  The overall supply of gold changes every year, with mining companies producing more and more of the metal annually, extracting it out of the ground and selling it to refining companies.  The total supply of gold is increased by about 1.5% each year, most of which goes towards the jewelry industry.  So, when supply constraints start to creep in for gold investments (i.e. coins and bars), this doesn’t necessarily mean that the world is running out of gold, but merely the annual supply of gold coins and bars is running low, which takes us to our next point.

2.               The annual supply and production of physical gold investments is not elastic, meaning that when demand goes way up, supply can quickly go down which drives the price of gold up.  Not only that, but it also drives the premiums of gold products up, making it pretty expensive to gain exposure to the metal during times when the supply is low.

With these things in mind, you can get a good idea of how supply can affect the price of gold, because even when the overall supply increases a little each year, the annual production rate of each mint does not reflect the total supply of gold around the world.  Now, let’s take a look at how demand affects the price of gold.

Demand usually goes up when 1) the price of gold takes a dip, 2) when volatile markets create fear-induced urgency among investors to protect themselves with gold, and 3) when premiums for gold products are lowered due to an increase in the supply chain.

Strength of the Dollar

The price of gold is almost always inversely related to the value, or strength, of the dollar.  When the dollar gains strength, gold tends move down; when the dollar loses strength it tends to drive the prices of gold higher.  This plays into the volatility of the gold market.  When economic uncertainties, or things like quantitative easing by the Federal Reserve, weaken the dollar, gold consequently moves up, due both to the drop in the dollar and increased demand that volatile markets bring.

Central Banks

Countries’ Central Banks hold both paper money and gold in their official reserves.  In recent years, we have found that Central Banks have been accumulating more and more gold, and diversifying away from paper money.  As banks begin to do this, the prices of gold rises, as they take this gold off of the market.  Many Central Banks around the world, including the Federal Reserve, the European Central Bank, and the German Federal Bank have reserves comprised heavily of gold right now. 

To summarize, supply and demand, strength of the dollar, and actions of central banks around the world are the main drivers of the price of gold.  But remember, 200 oz. holds the same inherent value as it did in Bible times—it is the worth of the paper dollar that changes, not the worth of the gold!  The price of gold fluctuates because it is measured in extremely volatile dollars, which actually shows that gold is a constant and the dollar is unreliable.  The fact that the market value of gold has increased so drastically since the 70s is because the dollar has been gradually losing value for decades.