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3 Factors Causing The Slump In Gold Prices

By Daniel MarburgerCommoditiesAug 20, 2018 12:10
uk.investing.com/analysis/3-factors-causing-the-slump-in-gold-prices-200203145
3 Factors Causing The Slump In Gold Prices
By Daniel Marburger   |  Aug 20, 2018 12:10
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Gold prices experienced a rocky rise in the first quarter of 2018 (Q1) and steadily dropped to almost the same point at the end of Q2, and remains in a downward trend until today. The article tries to answer what may have lead to the fluctuations and whether investors should worry about it.

Strengthening of US dollar

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

Source: tradingeconomics. com
Source: tradingeconomics. com

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

Source: coininvest
Source: coininvest

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

When the dollar gained value in Q2, the gold price fell because gold became more expensive in other currencies. The strengthening of the 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, although the dollar doesn't entirely explain gold’s movement.

Interest rate and expectation on inflation

One of the short term drivers is interest rates. Since gold doesn’t generate any interests, when interest rates increase, 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 rates. 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 of 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.

Jewellery demand slightly decreased, while there was 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 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 potential market stress.

The 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 few allies in the war, the extent to which the gold price is linked to the US dollar is determined by how long the US benchmark is.

3 Factors Causing The Slump In Gold Prices
 

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3 Factors Causing The Slump In Gold Prices

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