What economic factors affect the price of gold?

1) US Dollar

Like most internationally traded commodities gold is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.

The value of gold, a fiat commodity currency, will also be largely determined by its attractiveness relative to other fiat currencies – the fiat paper currencies issued by central banks. Gold will be most attractive when market participants are most nervous about the future value of other fiat currencies. And concern among investors tends to grow when governments appear to be spending too much (ie, increasing the size of their budget deficit) and/or when central banks do not do enough to contain rising prices. Inflation, of course, acts to erode the purchasing value of currency.

Gold prices have a relatively high inverse correlation against the dollar of around -0.35.

2) US monetary policy

Interwoven into the value of the US dollar is the current and expected future path of US monetary policy. Higher interest rates, reflected in higher bond yields reduce the attractiveness of holding non-interest bearing assets like gold. Gold is used as an investment alternative. Investors think that it protects money’s purchasing power. As an investment, it has to compete against other investments that are available in the market, like equities, bonds, real estate, and currencies, and the interest rate is one of the most important variables that determine the attractiveness of the other investment alternatives.

3) Jewellery / store of value demand

Gold is used for jewellery, accounting for over 50% of global demand. If consumer demand increases this may be reflected in higher jewellery demand, resulting in an increase in the price of gold.

Demand for gold in jewellery is particularly popular in China and India. Even gold jewellery is very popular, the metal is historically also used as a form of investment and financial security for married woman. Therefore, households tend to increase their purchases when prices fall, and vice versa when they rise.

4) Industrial applications

Around 10% of annual gold demand is attributed to medical and industrial uses for gold, where it is used in the manufacturing of medical devices like stents and precision electronics like GPS units. Due to the relatively small amount of gold going to industrial applications, changes in underlying demand have very little influence on gold prices.

5) Investment demand

Demand for gold as an investment (or hedge against uncertainty and higher inflation) 

tends to increase as concerns about higher inflation, prospects for a weaker US dollar and geopolitical risk grow. The growth in the market for Exchange Traded Funds (ETFs) have made it much easier for investors to take a position on gold. Previously, investors might have had to purchase gold coins and stored them securely.