Variables that Affect Gold Prices

Three economic variables that affect gold prices

The precious yellow metal is dollar-denominated. This means that when the price of the dollar moves, gold prices also shift. Both currencies are inversely correlated so when the dollar is down, the prices of gold go up and vice versa. According to historical data, the relationship between USD and gold are about 90% negative.

Gold prices get affected by littlest of things. This makes gold a good indicator of what’s going on in the global market.

Demand VS. Supply

Like any other commodity, the demand and supply of gold plays a huge role in determining its prices. Due to the limitations of gold, the supply is very much stable so demand plays a bigger part to its prices. You might be wondering why despite its limited resources, its current prices are on a steady decline. The reason for this is because of demand. Investment-grade bullion isn’t going up in prices now because it isn’t getting enough demand from investors. Today, gold prices are down because the dollar is very strong (inversely correlated) and investors are anticipating an interest rate hike in the U.S. next year. Gold doesn’t yield interest rates so people would rather invest in securities like bonds that produce high interest rates than commodities.

Inflationary warning

In recent years, central banks are buying more gold than they are selling. Gold bought by central banks in 2012 rose by 17% from 2011 at 534.6 tons. This was the highest level of gold buying by central banks since 1964, according to the World Gold Council. On the other hand, The Bundesbank – Germany’s central bank and quite possibly the world’s biggest support of the precious yellow metal – declared that it won’t be selling its gold until 2020. In 2003, Germany refused to sell any of its gold even if its prices were very low so it’s not surprising for investors to hear of such announcement. When investors see that central banks around the world are buying and keeping more gold, they deduct this as an act of preparation for a big inflationary threat.

Political unrest

When gold prices suddenly increase, there’s a huge chance that there’s something going on that can negatively affect the major currencies around the world. Gold is looked at as a secure way to keep assets in place when the future of a currency seems uncertain. During an invasion, the invaded country’s currency becomes worthless. But if people in that country have physical gold assets, they will have something to fall back on. This is the reason why gold prices spiked a little at the peak of the Russian invasion in Ukraine. The spike in gold prices during that time didn’t last long, but it’s a clear indicator that events like that affect gold prices.

In the end, gold will always be linked to currencies. The precious yellow metal’s value may decrease over time, but it will always be the metal used as hedge against uncertainty. Investors who want to have a good market outlook should regularly track gold since it’s very sensitive to factors that affect the economy.

Fed Tapering QE and the Price of Gold

fed tapering qe - the monster gets his revenge

If the threatened Fed tapering QE comes to pass, how will the price of gold be affected and what is the rational response of the individual trying to survive in the wacky world of a centrally planned US economy?

Should the government side with the devil, (let interest rates rise), or just dive into the deep blue sea, (keep monetizing new debt)? Either choice ends the same way – high inflation, more municipal defaults like Detroit, an economy that grinds eventually to a halt and – barring a miracle – either the default of the US government or a Big War to distract everyone. (Followed by the default of the US government once the shooting stops.)

What a choice, huh?

Here’s some of the factors our Overlords are dealing with daily:

Gold Down/Gold Up

Gold was down a bunch in April in response to someone selling 500 tons in one fell swoop. It was down a bunch more in May. The direction is now reversed. Gold is up this morning a bunch, up 10% in the last month. Can you say “volatility”? There, I knew you could do it.

QE or Taper

The Fed is dumping $85B a month into the equities markets via banks through their QE program for almost 2 years now. They are threatening to stop, or at least “taper” that program sometime soon. If the Fed stops QE, the bull market comes to an end. If the Fed keeps QEing, they will eventually own ever bond, mortgage and IOU in the world. They’ve already quadrupled their balance sheet in the last 5 years. That can’t end well.

Interest Rates vs. Inflation Rates

The official inflation rate is higher than interest rates, though not by much. Long bonds are at historically low yields. In the primary market, yields are actually below the inflation rate. Savers have almost no incentive to save in this market because the return on savings is negligible.  In real terms, the return on savings is negative – as anyone who actually pays for groceries, gas and housing has noticed.

Good Dollar / Bad Dollar

The US Government needs a weaker dollar, because its debt is denominated in dollars. But every other central bank on the planet has the same need – weaker currency. This is the reason for the infamous “race to the bottom.

The government is caught between a rock and a hard place. It’s run up debts that can’t be paid in current dollars with current growth. It needs more growth and a weaker dollar to pay the debt. But growth has to be organic, and the Fed is not allowing that. Growth requires investment, investment requires capital reserves, capital reserves demand higher interest rates, higher interest rates will create a stronger dollar and will also make it even harder to pay dollar-denominated debts.

So the game the Fed and the US government are trying to play is to stimulate growth in the absence of any of the factors that historically stimulate growth. Or, as my friend The Fearsome Pirate said, “centrally planning markets is impossible.”


Long gold.

Prices of gold are still well below where fundamentals say they should be. But I’d be buying – and taking delivery of – physical, not this goofy-ass paper stuff.

A Response to Toby Connor’s Thesis about the Gold Bear Raid

The “gold bear raid” was driven by the TBTF banks in an attempt to amplify their earnings. This is according to a  Toby Connor article on Resource Investor. In short, his thesis was that the TBTFs drove the price down so they could buy lower now so they could sell higher later. stack-of-gold-bullion-coins

Though I do not disagree with Connor’s technical analysis, I think his explanation for why the price of gold plummeted is just too damn complicated. Occams Razor tells us to look for the simplest explanation, and I think there are much simpler explanations than his.

First, the context: the price of gold fell from ~$1800 last October to less than $1300 in June. It’s recovered a bit of that price since then but is still down over 30% from October.  The fundamentals for gold haven’t changed.

In general, the main driver of gold’s price – at least in the West – is the expectation of monetary inflation. The main driver in Asia is simple demand .

Since the Fed is still creating $85B in brand new money every month, there is no change in the expectation that the new money won’t end up sloshing into the marketplace. Asians are still demanding gold in quantities that far outstrips supply, so there is no change from that perspective that would drive the price of gold down.

I think Connor overlooks at least two situations that serve as a better explanation for the drop in the price of gold.

In no particular order, they are:

  1. The disconnect between paper gold and physical gold
  2. Margin calls on big players

Its well-known that the supply of physical gold implied by the volume of “gold-backed” ETFs far exceeds the actual supply of physical. Nevertheless, paper gold has tracked the price of physical since it was introduced. If a big holder of paper deciding that the spread between implied supply and actual supply was just too big to justify, he might just decide to dump his paper. That could start a drop, which could then be exacerbated by other holders getting margin calls.

Suppose some of those getting margin calls were large holders of gold. Cyprus was proof that the Eurocrats will stop at nothing to keep the big banks afloat. Suppose some big hedge fund was massively short the Euro and massively long gold and found themselves on the wrong side of both those trades when the ECB decided to bail-in Cyprus? Or Portugal? Or Spain? Or Italy?

The amount of gold that was dumped on the market tends to argue that someone was reacting in “panic liquidation” mode, not coolly choosing to manipulate the price lower so they could buy a lot more so they could sell it a lot higher. That’s a cool theory, but it’s just too damn complicated to be believed. I’d put my money on forced liquidation due to margin calls.

Why Gold, (instead of anything else)?

If you lack understanding about what money is and what it does, you cannot begin to understand why gold is historically the best money. All good money will ideally posses these qualities:

  1. Durability – does it rust? rot? corrode? melt?
  2. Divisibility – does its value change when divided into smaller units? Two halves of one cow is not nearly as valuable as one whole cow.
  3. Portability – Can it be easily transported?
  4. Non-counterfeit-ability – the reason for this attribute should be obvious
  5. Homogeneity – are different units of the same size essentially identical? Not all oranges are identical, nor are all cows. OTOH, gold is gold is gold is gold.

Gold has been the preferred form of money for 5000 years because it is a commodity that possesses all of these qualities.

All fiat currencies are portable, homogenous and divisible. But they are easily counterfeit-able, (just crank up the printing press and make more!), and not remotely durable.

If you look at the list of hard commodities traded on the Chicago Mercantile Exchange, you will see various commodities that have been used as money over the millenia. For use as money, though, they all have drawbacks of one sort or another. All except for gold.

Silver is closest to gold in usefulness as money, but its main use is industrial which actually dilutes its value as money. Platinum is similar to silver, but much rarer than gold. In fact, all the industrial and rare-earth metals share gold’s qualities, but they all have significant industrial uses. Strangely, because Gold is nearly useless as an industrial metal, it is actually more useful as money.

Oil has most of the properties of “good” money as well. It doesn’t degrade over time, is very easily divisible, and impossible to counterfeit. But because it is a liquid, it tends to be difficult to transport. And of course, like silver, it also has great industrial use.

Salt was used as money in the past, but it lacks durability. A good rainstorm or flood makes your money literally dissolve before your eyes. Livestock and agricultural commodities have also been used as money, but they all lack one or more of the monetary qualities that gold possesses.
Commodity-based monies impose fiscal discipline on governments. If a government wants to run a deficit, they have to come up with a way to collect actual money. They can take it from the people by force, but they cannot create it out of thin air.

Imagination-based monies, (fiat), impose no such discipline. With a fiat money, government is free to run up huge debts, and then pay them off with even more money they create out of thin air. (In other words, exactly what modern governments are doing.) This makes it much easier to do incredibly stupid things, like start crazy wars, support military excursions around the globe, and bail out giant banks that make crazy, risky bets and lose.

When is the best time to buy gold?

For those of you asking yourselves, “should I buy gold”, the answer is pretty simple – YES. For those of you wondering, “should I buy gold now that it is over $1900, or should I wait?”, the answer is – THAT DEPENDS. Gold continues to push higher because of fundamentals – it is a commodity and all commodities are going to be rising in dollar terms for as long as central banks try to inflate their way out of debt.

If you want a little “better” price on your gold purchases, (and gold is technically overbought at the moment, which implies a coming correction), a good entry point is on any pullback to a prior support level. At this date, we had a brief pullback two weeks ago to the mid $1700’s before rocketing back up to near $1900. If you want to find a good entry point, select price levels that appear to provide support.

There are two kinds of support – absolute price support and relative chart support. Absolute price support means that a particular price point – say for example $1700 – has historically provided support. The simplest way to identify absolute price support is to look at a chart. Wherever you see the price chart fall down to a particular point and then reverse back up – that’s support. The support is stronger if the reversal has happened on more than one occasion.

The other kind of support – chart support – is more ambiguous. This kind of support can be seen with technical indicators like moving averages or price bands. (Here’s an example from 2008.) There is no “right” moving average and no “right” price band – these are purely subjective indicators, but – in spite of their subjective nature, can still provide fairly reliable entry points. If you look at a chart of gold over the last ten years, you’ll see it’s general trend is up, but that it is marked by pullbacks. Often, those “support” levels you see on the chart will coincide with moving averages. Try looking at a 20day, 50day and 200 day moving average of Gold’s price and you’ll like see support. (There is nothing magic about these levels, by the way. You can pick any number you want – try a 14 day, 37 day and 83 day moving average just for grins and giggles.)

Whatever your entry point, you should find a way to buy gold because the fundamentals support it: central banks are destroying the value of their currencies, and that action in turn means that all commodities will rise in value relative to those currencies.

Finally, a word about the various ways to own gold.  Buy physical gold, not an ETF such as GLD. If you buy futures contracts, take physical delivery. Buy one ounce coins or tenth-ounce coins or even kilo bars, but buy physical.