Gold must have a guaranteed place in a diversified investment portfolio. It is an asset with unique characteristics, usually with low volatility, strong perception of value, high liquidity and always a much sought after alternative in times of turbulence in markets, economy and world geopolitics.
Known in the markets as a yellow metal, this raw material has not shone in recent months. However, the conditions seem to be in place for a positive trend in the price of this raw material, as we will detail later in this article.
Gold also has the advantage of being an asset that is decisively influenced by a very small set of factors, so it is easy to understand and anticipate its movements .
Factors Influencing The Price Of Gold
These are the main factors that influence the evolution of gold, and which must be followed closely by those who invest in this asset:
- Dollar. The exchange rate of the US currency is decisive in defining the course of the quotation. The dollar is the main reserve currency in the world, competing with gold in this status. That’s why these two assets usually have an inverse correlation. That is, when the dollar appreciates, gold tends to follow the opposite movement . If the US currency devalues, the attractiveness of gold is reinforced. In moments of strong turbulence, the dollar and the metal can even follow identical paths, but it is more usual for variations to have different signs. Being quoted in dollars, for European investors with gold in their portfolios, the drop in the price of this precious metal can be offset by the exchange rate appreciation.
- Interest Rates. In addition to the dollar, bonds are also a “competent competitor” to gold. Hence, the raw material is penalized by an aggressive monetary policy, as higher interest rates reinforce the attractiveness of debt securities (public and corporate). If yields are high, investors increase their interest in bonds in search of attractive returns with lower risk. Low interest rates reinforce the appetite for gold .
- Economic Data. As they influence the price of currencies and the decisions of central banks, economic data are also very important in the dynamics of the price of raw materials. Periods of economic slowdown or recession are favorable for gold . High inflation, despite putting pressure on interest rates, is also usually favorable for the yellow metal, which is seen as a good option to protect an investment portfolio from the persistent rise in prices of products and services.
- Geopolitics. When a terrorist attack occurs, a military conflict or any other event of tension in world geopolitics, gold is usually one of the first assets to react on the rise. The metal is seen as one of the main safe haven assets by investors , so it tends to benefit in times of turbulence and uncertainty.
As gold is a raw material, it is obviously also influenced by the balance of forces between demand and supply . India stands out as the biggest consumer, mainly due to the religious cult, with the quotation often increasing when the wedding season happens in what is the second most populous country in the world.
Central banks are also a powerful “customer” for gold , with the precious metal accounting for a sizable portion of the reserves of many monetary authorities around the world. The Bank of Portugal, for example, holds 382.6 tons, which in April were valued at close to 20 billion euros. It is the 14th largest gold reserve in the world and is equivalent to almost 10% of Portuguese GDP.
As far as supply is concerned, China, Australia, Russia and the United States are the world’s largest producers , with several countries in Latin America and Africa also playing a relevant role in the industry.
In analyzing the evolution of the gold price, none of the factors can be seen in isolation or as a simple rule. Mainly because they are often divergent. Theoretically, the slowdown in the economy is positive for gold, but it will also have a negative impact on demand for the yellow metal, which could put downward pressure on the price. Rising inflation favors gold, but also puts pressure on central banks to raise interest rates, which also benefits the dollar and bonds.
Gold Depreciates After The Start Of The War
From a longer term perspective, gold has performed remarkably. This precious metal registered a spectacular appreciation from the beginning of the century until 2012, accumulating 12 consecutive years of gains. In this period, the quotation increased more than six times, going from less than 300 dollars per ounce at the end of 2000, to more than 1,600 dollars at the end of 2012 .
Gold benefited at that time from the status of safe haven asset, taking advantage of the hangover of the “dotcom” crisis at the beginning of the century, the global financial crisis in 2008 and the debt crisis in 2011.
A period of correction followed for three years and then a phase of ups and downs, which culminated in an all-time high above $2,000 per ounce in March 2020, in the early days of the Covid-19 pandemic. The yellow metal returned to records in March this year, driven by uncertainty and turmoil generated by Russia’s invasion of Ukraine .
The market is now in a new phase, which may be benign for gold given the increasingly pronounced prospects that the global economy is heading towards a recession, which will limit the aggressiveness of central banks in raising interest rates. Reflecting these factors, gold has been recovering some ground in recent weeks, as the dollar loses strength and bond yields ease from highs . The episode of opposition to Nancy Pelosi’s visit to Taiwan, by China, also boosted quotations.
Although the conditions are met for gold to shine again, the raw material is not immune to the volatility of listed assets and behavior that is not always in line with the fundamentals of the economy, the sector and the market.