Gold is seen by many to be the premier safe haven to invest in when times are tough. Following the global economic meltdown in 2008, the price of gold rose steadily as more investors protected their investments by buying gold. The price hit an all time high of $1895 per troy ounce in September 2011, but since then has been on a downward trend, recently returning to levels not seen since 2010. We will look at the cause of the price falls and examine whether this is likely to change anytime soon.
There are several drivers for the price of gold – the strength of the US dollar, investor sentiment, the general price of other commodities, other precious metals and of course supply and demand.
It is received wisdom that the gold price moves opposite to the US dollar. Therefore when the dollar is strong the price of gold is weak and vice versa. When you compare the movement of the USD/EUR rate with the price of gold we can see this in effect. With gold commonly traded in dollars, when the dollar is strong you can buy more gold for your dollar, making it cheaper in real terms. Consequently, the drivers for the US dollar – US economic confidence, the price of oil etc, can also play an important part in the price of gold. Much of the advice for investors will be to examine what is happening in the US economy. If the interest rate falls, the unemployment rate rises, quantitative easing is continued or stopped and so forth can all affect the price of gold in the short term.
Investor sentiment and the economy
In the longer term though, a wider picture needs to be viewed. The US economy can affect the dollar, but so can the global economy and in turn investor sentiment. As mentioned earlier gold is seen as a safe haven to invest in and when there is concern over the global economy, investors will turn to gold rather than riskier agricultural commodities such as coffee or sugar that are dependent on weather for the success or failure of their crops. With the current problems with the Chinese economy and the onset of the El Nino weather phenomenon, which could adversely affect many agricultural commodities, it would seem that the price of gold should stabilise or rise.
The commodity factor
That’s not likely to be the case though, because after several years of record crops and the fall in the price of crude oil, the commodities markets are generally very low. For investors, that would mean that the balance of risks and gains is tempting and therefore gold is not necessarily top of their investment lists. Although, it is thought that agricultural commodities are likely to rise in the coming year, they are not expected to rise as high as the peaks of 2011/12 when poor crops in major producing regions caused a number of traded commodities to hit new highs. At the same time the gold price rose as investors “jumped ship” from agricultural commodities to safer bets.
Silver, platinum and the other metals
The other precious metals also have a bearing on the price of gold, and gold can have a bearing on the price of other precious metals. The investor choice aside, silver, platinum, and rhodium are all attractive consumer desired metals and the price of these can affect the mix of metals used in jewellery. In some industrial situations, gold is the preferred choice, but when the price is high, alternatives with similar corrosion resistant and conductive properties are looked for. Although, there is no perfect substitute as yet, nickel, copper, palladium and platinum can be utilised to reduce the amount of gold used in electronics (the main industrial use of gold). The reduction or increase in the use of gold will usually result in the opposite effect in the other metals. However it should be noted that industrial uses account for only about 10% of the total use of gold, and so the effect can be quite minor.
Supply and demand
Linking all of these factors is the supply and demand of gold. The demand for jewellery is linked to the economy and the strength of the dollar. In recent years the greatest demand has been from China and India as both cultures prize gold highly and the population’s disposable income has grown. The recent fall in economic outlook for China will certainly impact the demand for gold. In 2014, the total demand for gold fell by 5% y-o-y to 4,242 tonnes, the lowest level since 2010. Provisional figures for 2015 show demand to be falling further.
When the price of gold is high, it becomes economical for more marginal gold reserves to be mined. New high grade gold deposits are becoming harder and harder to find, and consequently more expensive. As the price of gold was so high between 2011 and 2013, more investment was made in gold mining and consequently the supply of gold rose. The high price of gold also meant that more gold was recycled over the period 2008 to 2011 with a 70% increase from 2008 until 2014. While the amount of gold recycled in 2014 fell back to 2008 levels, the amount of mined gold has continued to rise. In 2014, the amount of mined gold supply was 3,234 tonnes, up 60% from 2007’s level of 2,026 tonnes.
The higher supply and fall in demand has meant that there will be a surplus of gold in 2014 of 160 tonnes, compared to a deficit of 188 tonnes in 2013. It is estimated that the surplus will rise in 2015.
So what does this all mean for the price of gold now? The next thing to look out for will be the US Federal Open Market Committee’s decision on interest rates due on Thursday 17th September. The result of that decision will drive gold prices in the short term, but in the long term there seems to be no real respite from falling gold prices, with low commodity prices, low metal prices and low demand but higher production.