There are three main factors that influence the price of gold: its role as protection against inflation, as a hedge against economic catastrophe, and as a reflection of interest rates.
Inflation often prompts investors to buy gold as a value safeguard. For instance, in 2022, gold demand rose 12% YoY as consumer prices increased by 9.1%. Between 1974-2008, during eight years of high U.S.
inflation, gold prices grew by an average of 14.9% YoY, hinting at a link between inflation and gold demand. However, factors like supply, futures trends, and investor sentiment also play a role in gold pricing. While the 1970s saw gold as a robust inflation hedge with 35% annual returns, its post-1970s performance has been variable, sometimes even showing negative returns during inflationary phases.
Despite the U.S. CPI crossing 4% in 2021 for the first time since 2008, gold's growth was only 1%. Gold's relation to the CPI is volatile in the short term, challenging its consistent role as an inflation hedge.
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Now we'll explore the intricate relationship between gold, central bank policies, and interest rates, and how they collectively influence the global financial landscape.
Central banks view gold as a crucial reserve, influencing its prices. They hold around 35,000 metric tons, or one-fifth of all mined gold, for diversification, trust, and its counter-balance to the US dollar. When economies flourish and foreign reserves grow, banks may reduce gold holdings since gold lacks the returns of bonds. As gold interest lessens during such times, banks risk driving its prices down. Hence, they follow the Washington Agreement, limiting gold sales to 400 metric tons annually, to prevent market disruption. Traditionally, countries like the U.S. and Germany were major gold holders, but now Russia, China, and others are active buyers.
Gold has historically been an inflation hedge. Yet, its short-term relationship with the Consumer Price Index shows fluctuations, suggesting factors like interest rates and market volatility play crucial roles. The gold-real interest rates connection is changing; even with inflation-adjusted rates at highs, gold remains stable. This new pattern makes assessing gold's "fair value" challenging. Gold's value stems from Central Bank purchases, investor behaviour, and an existing premium. While gold is still a long- term inflation buffer, short-term prices are influenced by interest rates, market shifts, and major financial decisions. Some investors question gold's investment draw during current bond yields and potential US economic slowdown.
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Geopolitical tensions, like the recent conflict between Hamas and Israel, significantly impact the gold market. During global uncertainties, investors lean towards safe-haven assets, with gold being a prime choice due to its reputation for stability. Following the start of the mentioned hostilities, gold's price increased by 5%, even seeing a 3.1% rise in a single day. Despite speculative positions, gold's value as a refuge during geopolitical crises is clear.
