3 factors causing the slump in gold prices

Gold price has experienced a rocky rise at the first quarter of 2018(Q1) and steadily dropped to almost the same point in the end of Q2 and remains downward trend until today.

The article tries to answer what may lead to the fluctuations and should investors worry about it.

Strengthen of US dollar

Normally measured in US dollar, gold price is directly linked to the US dollar. Historical data shows a reverse trend of the movement between gold price and dollar.

Figure 1. US Dollars Index in the last 5 years, measures the performance of dollar against a package of other currencies including EUR, JPY, GBP, CAD, CHF and SEK. (Source: tradingeconomics. com)
Figure 1. US Dollars Index in the last 5 years, measures the performance of dollar against a package of other currencies including EUR, JPY, GBP, CAD, CHF and SEK. (Source: trading economics. com)

 

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Figure 2. Movement of gold price in US dollar in the last five years. (Source: coininvest.com)
Figure 2. Movement of gold price in US dollar in the last five years. (Source: coininvest.com)

When the dollar gained value in Q2, gold price fell. Because gold price becomes more expensive in other currencies. The strengthening of dollar drives domestic and foreign investors to add holdings of the currency. In the long term, there is a consistently negative correlation between dollar and gold, while dollar won’t explain gold’s movement entirely.

Interest rate and expectation on inflation

One of the short term drivers is interest rate. Since gold doesn’t generate any interests, when interest rate increases, the cost of holding gold is higher. The US Fed Fund rate is also observed to be rising.

Whether to invest in gold or securities depends partly on people’s expectations for inflation.  A higher expectation on inflation would drive investors to invest in gold. Besides, inflation is closely related to interest rate. A rising interest rate may indicate a lower expectation of inflation, thus the demand of gold decreases.

A glance at the fundamentals

From the perspectives of gold demand and supply, gold supply saw an increase up to 3% in Q2; gold demand was also 4% weaker mainly due to slower ETF inflows.

Source: Metals Focus; World Gold Council
Source: Metals Focus; World Gold Council

Among the major sources of gold demand, volume in ETF changed the most, while US investors focused more on improving domestic economy, European-listed funds witnessed a rapid growth due to uncertainty from Italian elections and monetary policies.

Jewelry demand slightly decreased, while there were noticeable growth in the demand of central bank reserve, bar and coins, and gold used for technology sectors such as electronics.

Summary

Gold price fluctuates around fundamentals as it used to be in history. But since the measurement of price, the US dollar moves reversely, there might be a relatively stable value.

And because of the low correlation with other financial markets, investing in gold and other precious metals serves as a good role for the diversification of portfolios.  Furthermore, gold is worth owning when there is a potential market stress.

Gold price may bound back once the US market starts calming down after the booming at the beginning of the trade war.  Or since there are little allies in the war, how much would gold price be linked to the US dollar is determined by how long will the US be the benchmark.

Contributed by Daniel Marburger, Managing Director and Coininvest

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