Exploring Five Influential Factors on Gold’s Value

With gold achieving an all-time record high earlier this week, the first question on many investors’ minds is whether this bullish pattern will be short-lived. Gold gains its value from a variety of complex factors, all influencing its recent climb to over $2,100 per ounce. When these factors work in harmony, gold can gain over $200 per ounce in just a few short weeks, as we’ve seen with the climb that started on October 7.

1. Inflation

The first factor influencing gold’s value is inflation. Many traders use gold as a tool to hedge against inflation because of its known ability to preserve value even as other commodities fail. As inflation rises and the U.S. dollar falls, causing the purchasing power to decrease, gold excels, allowing investors to store their wealth with a secure, tangible asset.

Gold performs best during periods of inflation because of this inverse relationship. When the economy dwindles, gold gains safe-haven demand, with inflation eroding the appeal of more common investment tools, like stocks and bonds. Gold has an intrinsic value and limited supply, making it the perfect inflation hedge.

2. Market Sentiment

The overall market sentiment influences nearly all commodities, including gold. Market sentiment stems from numerous external factors, such as geopolitical tensions, economic uncertainties, and financial crises. For example, a war overseas, risks of a government default, or fears of a recession can all sway the market sentiment, inciting investor fears.

The level of stability versus fear in the market affects safe haven demand. When traders fear various events, such as an upcoming war or economic depression, they prefer to invest in safe-haven assets that can protect their wealth when the economy crashes. The global economy affects overall commodity prices, so traders often prepare for the worst by investing in safe-haven assets during times of economic uncertainty.

We’re seeing a perfect example of this unfold right now as tensions in the Middle East between Israel and Palestine heighten. The first attack on Israel occurred on October 7, and since then, gold has increased by over $200 per ounce, climbing to an all-time price high of over $2,100 per ounce. With commodity markets experiencing turbulence from the widespread tensions, more traders are seeking a secure option to protect their wealth.

3. Currency Exchange Rates

Gold is a global asset, with its price denominated in various currencies. When commodity prices change, so can currency exchange rates, which ultimately impact the price of gold.

For example, a weak U.S. dollar typically makes gold cheaper for international buyers. The same applies to gold prices in other currencies.

4. Interest Rates

Central banks often increase interest rates during periods of high inflation to reduce borrowing. High interest rates increase the opportunity costs of investing in non-yielding assets, like gold. While gold may perform best during periods of high inflation, its performance can be curbed by hawkish monetary policies.

As the opportunity cost rises, some investors shift their eyes toward assets that can accumulate interest. This process can reduce gold demand, ultimately dampening its performance rates.

When interest rates decrease as central banks soften their monetary policies, gold often gains increased investor demand with diminishing opportunity costs.

We’re currently experiencing the back end of this process as the U.S. Federal Reserve approaches the end of its interest rate hiking cycle, offering support to the gold market. This dovish strategy, combined with the tensions overseas, has allowed gold to reach its recent highs.

5. Supply and Demand

As with any other asset, gold prices are affected by supply and demand rates. One of the primary factors affecting gold supply rates is the mining sector.

Commodity prices ultimately impact production costs, which can affect the final supply levels we see. When market prices go up, production rates decrease, reducing gold supplies and increasing prices. The labor market can impact production rates as well.

Central banks also impact total supply levels. Right now, central banks carry about one-fifth of the world’s gold.

How central banks decide to buy or sell gold each month can significantly shift the globe’s supply levels. When central banks purchase high levels of gold, as they have been lately, gold demand often increases from the heightened market sentiment of the commodity.

Clearly, many factors affect gold performance rates, and right now, we’re witnessing a perfect storm. How this will continue to play out is unclear, but we do know that interest rates should begin dropping in 2024, and central banks plan to continue buying gold based on World Gold Council surveys. As always, investors should consult their advisors before making any portfolio decisions.

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