Gold does well in a volatile socioeconomic environment because it is non-correlated to other assets like stocks and bonds. Gold is also often used by central banks to diversify their monetary reserves away from paper currencies.
Long-term drivers include market risk, opportunity cost and momentum. Gold prices are known to drop slightly at the beginning of recessions.
The London Gold Fix
The London Gold Fix is the mechanism by which daily prices are set for physical bullion trading. The process was first introduced in 1919 and currently takes place twice each business day via a dedicated phone conferencing system. It was formerly held at the London offices of N M Rothschild & Sons but since 5 May 2004 Barclays has taken over.
The participants state the price at which they are prepared to buy and sell gold bullion for their customers, then a consensus is reached. It is important that buyers and sellers are on the same page, and this helps ensure that large pools of orders overhanging the market can be executed at a common price.
The Gold Fix is used by many miners, central banks and jewellers worldwide to trade gold bars, value stocks and price derivative contracts. It is also a key benchmark for the wider gold market. In recent years, accusations of the Gold Fix being rigged have led to increased transparency and regulation in the industry.
The Futures Market
Many factors affect the Gold rate, including supply and demand. The market’s view of the role of gold in the monetary system can also have an impact on prices. A decision to reduce the monetary role of gold would likely cause prices to rise, while an expectation that the monetary role of gold will increase would probably drive them lower.
Speculative demand can also influence gold prices, especially when it’s misguided. Prices rise when speculators anticipate rising demand and prices fall when expectations of falling demand are higher than reality.
Interest rates can also have an impact on gold prices, as they do with the price of almost all commodities. When interest rates are high, investors tend to invest in deposits, which yield a nominal return but not real money, causing investment demand for gold to decrease and pushing prices down. Similarly, when interest rates are low, investors tend to purchase deposits and invest in gold funds, driving demand for the precious metal and pushing prices up.
The Spot Market
The spot market is where you can buy or sell Gold at a price determined by supply and demand. The price set in this market is based partly on activity in the futures market, and is updated throughout trading days. It can also be influenced by factors such as the LBMA Gold Fix (as discussed above).
The price of Gold is often affected by geopolitical tension, because it is seen as a safe-haven asset and may provide protection against inflation or other financial crises. However, this effect is not always significant, and can be offset by changes in speculative demand.
The fact that a large proportion of the world’s gold is held by private investors and central banks means that small shifts in expectations can have significant effects on prices. This also contributes to the high level of volatility seen recently in the Gold market. This is especially true because the underlying economic situation is unstable.
The Bullion Coin Market
As a precious metal, gold bullion coins are valued based on their gold and silver content. Bullion coin prices fluctuate daily as they are bought and sold in the market. Most coins are minted on a limited run, and some sell out quickly. Bullion coins are mainly purchased for investment purposes or as collectibles.
Prevailing trends in the global economy also affect pricing. During periods of economic uncertainty, investors gravitate toward safe-haven assets like gold. This increases demand for the metal and drives its price up.
When the prevailing trend is for countries to increase interest rates, gold tends to be valued lower as Treasuries offer more attractive returns. However, when investors believe the Fed won’t be able to rein in inflation and there is a risk of another financial crisis, gold’s value shoots up. This is known as a flight to quality. In the case of Gold, investors turn to its finite supply and proven track record as a money safe-haven.
