• Seven factors that influence Gold

    UNITED STATES October 15 2016 9:32 AM

    NEW YORK (Scrap Register): It's been a wild year for stocks, but it's been nothing short of an exceptional year for physical gold and gold investors.

    Gold began the year at $1,060.80 an ounce, and it was mired in a multi-year downtrend that had seen the lustrous yellow metal lose about $850 an ounce from its all-time high. Pessimism abounded throughout the gold industry as miners were seemingly more likely to be writing off assets and cutting capital expenditures than developing or expanding their mines.

    However, things reversed very early in 2016. Physical gold had its best quarterly gain in 30 years during the first quarter, and year-to-date, even with its recent swoon, physical gold is higher by roughly $200 an ounce.  Gold has firmly reestablished itself as being in a bull market, and it's attracted both short- and long-term investors in the process to the physical metal and miners.

    Yet, the fundamental and psychological factors that move gold prices are largely unknown or overlooked. With that being said, let's have a look at the seven most common factors that influence physical gold prices.

    1. Monetary policy/Fed speak

    Perhaps the biggest influence on gold prices is monetary policy, which is controlled by the Federal Reserve.

    Interest rates have a big influence on gold prices because of a factor known as "opportunity cost." Opportunity cost is the idea of giving up a near-guaranteed gain in one investment for the potential of a greater gain in another. With interest rates holding near their historic lows, bonds and CDs are, in some cases, yielding nominal returns that are less than the national inflation rate. This leads to nominal gains but real money losses. In this instance, gold becomes an attractive investment opportunity despite its 0% yield because the opportunity cost of forgoing interest-based assets is low. The same can be said of rising interest rates, which boost interest-bearing asset yields and push opportunity costs higher. In other words, investors would be more likely forgo gold as lending rates rise since they'd be netting a higher guaranteed return. 

    Federal Reserve commentary can also move the gold markets. The Federal Open Market Committee, which holds meetings about once every six weeks, discusses the state of the U.S. economy and the future of monetary policy. If the FOMC takes a stance that implies rates could rise in the near future, the gold price tend to react poorly since, once again, the opportunity cost of forgoing interest-bearing assets rises. However, if the FOMC insinuates that rates are planning to hold steady, gold prices tend to rise since the opportunity cost of forgoing interest-based assets instead for gold remains low. 

    2. Economic data

    Another driver of gold prices is U.S economic data. Economic data, such as the jobs reports, wage data, manufacturing data, and broader-based data such as GDP growth, influence the Federal Reserve's monetary policy decisions, which can in turn affect gold prices.

    Though it's not set in stone, a stronger U.S. economy -- low unemployment, jobs growth, manufacturing expansion, and GDP growth in excess of 2% -- has a tendency to push gold prices lower. Strong economic growth implies that the Fed could make a move to tighten monetary policy, thus impacting the opportunity cost dynamic discussed above. On the flipside, weaker jobs growth, rising unemployment, weakening manufacturing data, and subpar GDP growth can create a dovish Fed scenario on interest rates and increase gold prices.

    3. Supply and demand

    It may be an oft-overlooked point, but simple supply and-demand economics can influence physical gold prices as well.

    As with any good or service, increased demand with constrained or low supply has a tendency to pull prices of that good or service higher. Conversely, an oversupply of a good or service with stagnant or weak demand can push prices lower.

    According to the World Gold Council, gold demand during the first-half of 2016 grew 15% to 2,335 tons, with investment demand surging 16% to its highest levels since 2009. However, gold supply only increased by 1% during the first-half of 2016, which represents the slowest rate of first-half supply growth since 2008. Growing demand and constrained supply has been a reason gold prices have headed higher this year.

    4. Inflation

    A fourth factor that can impact gold prices is inflation, or the rising price of goods and services. While far from a guarantee, rising or higher levels of inflation tends to push gold prices higher, whereas lower levels of inflation or deflation weigh on gold.

    Inflation is almost always a sign of economic growth and expansion. When the economy is growing and expanding, it's common for the Federal Reserve to expand the money supply. Expanding the money supply dilutes the value of each existing monetary note in circulation, making it more expensive to buy assets that are a perceived store of value, such as gold. This is why quantitative easing programs that saw the monetary supply expand rapidly were viewed as such as positive for physical gold prices.

    In recent quarters inflation has been relatively tame (just above 1%). A lack of inflation has been one factor that's coerced the Fed not to raise lending rates, but it's also held down gold prices which typically perform better in a rising inflation environment. This push-pull between interest rates and inflation can play a constant tug-of-war on gold prices. 

    5. Currency movements

    The movement of currencies – very specifically the U.S. dollar, since the price of gold is dollar-denominated – is another strong influencer.

    A falling U.S. dollar has a tendency to push gold prices higher because other currencies and commodities around the world increase in value when the dollar falls. On the contrary, a strengthening U.S. dollar often comes about because of a growing U.S. economy. It also pushes down gold prices since gold and the U.S. dollar have an inverse relationship. A weaker U.S. dollar in 2016 has been pivotal in pushing gold prices higher.

    6. ETFs

    Among these seven factors, the actions of electronic-traded funds, or ETFs, are more than likely the smallest influencer of gold prices. ETFs aren't designed to be market movers, but they're still worth mentioning.

    ETFs are basket funds investors can purchase that allow for increased liquidity and the potential ability to spread their risks over a large number of assets for a minimal cost. The largest gold ETF, the SPDR Gold Shares ETF, purchases or sells physical bullion based on demand from investors. As investment demand for gold changes, the price can be affected by the purchasing and selling activity of ETFs. Cash inflows for gold ETFs have surged in 2016, causing the purchasing activity of ETFs to increase as well. This purchasing activity is likely having a positive impact on the price of gold.

    7. Uncertainty

    Lastly, the broad factor of uncertainty can influence gold prices.

    There's no one specific factor that can be listed here that perfectly encompasses the uncertainty that can move gold, but political uncertainty and/or instability is probably the best example. Put plainly, the stock market covets certainty, and it's often the enemy of gold prices. Not knowing how Brexit will turn out for the U.K. and Europe, who'll become the 45th president in the U.S., and whether terrorist threats in the Middle East can be dealt with, are all factors that can contribute to global growth uncertainty and aid in rising gold prices.

    The one thing investors have to keep in mind is that uncertainty isn't a quantifiable statistic like many of these other points. It's a completely psychological factor that's investor-dependent, and it can differ from one event to the next.

    Source: Fool.com

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