Gold is highly sought after, not just for investment purposes and to make jewelry but also for use in the manufacturing of certain electronic and medical devices. As of February 2023, the price of gold was more than $1,870 an ounce. While down around $100 from a high posted in April 2022, it is still up considerably from levels under $100 seen 50 years ago. But what factors drive the price of this precious metal higher over time?
- Investors have long been enamored by gold, and the price of the metal has increased substantially over the past 50 years.
- Not only does gold retain additional value, but supply and demand have a huge impact on the price of gold—especially demand from large ETFs.
- Government vaults and central banks comprise one important source of demand for gold.
- Gold sometimes moves opposite to the U.S. dollar because the metal is dollar-denominated, making it a hedge against inflation.
- Supplies of gold are primarily driven by mining production.
How Gold Prices Are Determined
Central Bank Reserves
Central banks hold paper currencies and gold in reserve. As central banks diversify their monetary reserves (away from the paper currencies they accumulate and into gold) the price of gold typically rises. Many of the world’s nations have reserves that are composed primarily of gold.
Bloomberg reported that global central banks have been buying the most gold since the United States abandoned the gold standard in 1971, with 2019 figures dipping just modestly from 2018’s 50-year record. After a downtick in central bank gold purchases in 2020, the pace picked up again in 2021 and surpassed the 50-year record again in 2022. The top gold buyer in 2022 was the central bank of Türkiye, followed by Uzbekistan, India, and Qatar.
Value of the U.S. Dollar
The price of gold is generally inversely related to the value of the U.S. dollar because the metal is dollar-denominated. All else being equal, a stronger U.S. dollar tends to keep the price of gold lower and more controlled, while a weaker U.S. dollar is likely to drive the price of gold higher through increasing demand (because more gold can be purchased when the dollar is weaker).
As a result, gold is often seen as a hedge against inflation. Inflation is when prices rise, and by the same token, prices rise as the value of the dollar falls. As inflation ratchets up, so does the price of gold.
The impact of inflation and the value of the dollar can be seen in the recent price action of gold. As inflation soared in 2022, the price of gold actually declined throughout much of the year, partly owing to the strength of the dollar against other world currencies. However, after hitting a low of less than $1,630 per ounce in September and October 2022, the price of gold began to recover, with the persistence of inflation and concerns about a recession bolstering prices throughout the fourth quarter and into 2023.
Worldwide Jewelry and Industrial Demand
Jewelry accounted for approximately 44% of gold demand in the first half of 2022, according to the World Gold Council. India, China, and the United States are large consumers of gold for jewelry in terms of volume. Another 7.5% of demand is attributed to technology and industrial uses for gold, where the metal is used in the manufacturing of medical devices like stents and precision electronics like GPS units.
As such, gold prices can be affected by the basic theory of supply and demand. This means that as demand for consumer goods (like jewelry and electronics increases), the cost of gold can rise.
During times of economic uncertainty, as seen during times of economic recession, more people begin investing in gold because of its enduring value. Gold is often considered a safe haven for investors during turbulent times.
When expected or actual returns on bonds, equities, and real estate fall, the interest in gold investing can increase, driving up its price. Gold can be used as a hedge to protect against economic events like currency devaluation or inflation. In addition, gold is viewed as providing protection during periods of political instability.
Gold also sees demand from exchange-traded funds (ETFs). These are securities that hold the metal and issue shares that investors can buy and sell just like stocks. The SPDR Gold Trust (GLD) is the largest and held more than 915 tons of gold in January 2023.
While some ETFs represent ownership in the actual metal, others hold shares of mining companies rather than actual gold.
Major players in worldwide gold mining include China, South Africa, the United States, Australia, Russia, and Peru. The world’s gold production affects the price of gold, another example of supply meeting demand. Gold mine production was roughly 3,000 metric tons per year in 2020 and 2021, down from a peak of around 3,300 metric tons per year in 2018 and 2019.
Despite increases starting around 2010, gold mining production has not changed significantly since 2016. One reason is that the easy gold has already been mined. Miners now have to dig deeper to access quality gold reserves. The fact that gold is more challenging to access raises additional problems: Miners are exposed to additional hazards, and the environmental impact is heightened. In short, it costs more to get less gold. These add to the costs of gold mine production, sometimes resulting in higher gold prices.
What Makes Gold so Valuable?
The value of gold is rooted in the history of human civilization, as the metal has remained a symbol of wealth for thousands of years. The value of gold ultimately stems from a social construction, based on the agreement that gold has been valuable in the past and will remain valuable in the future. In addition, gold’s attractiveness revolves around its capacity to maintain its value over time and its uses in jewelry and technological products.
What Drives Fluctuations in Gold Prices?
Although the metal has proven its capacity to maintain its value over time, the price of gold is often volatile over the short term. There are many factors that influence the price of the metal. Because gold is generally dollar-denominated, a stronger U.S. dollar tends to drive gold prices lower, and vice versa. Real and expected inflation rates also affect the price of the metal. Gold purchases by central banks have an impact on the price, as does demand for gold to be used in jewelry and technological devices.
Should I Invest in Gold?
Gold adds an important layer of diversification to an investment portfolio because it has shown a negative historical correlation with other asset classes. In other words, when investments such as stocks and bonds falter, gold has a tendency to outperform. Investment exposure to gold is useful to hedge against inflation and to add a measure of safety to your portfolio in difficult economic times.
The Bottom Line
We have long been, and will likely continue to be, enamored by gold. Today, the demand for gold, the amount of gold in the central bank reserves, the value of the U.S. dollar, and the desire to hold gold as a hedge against inflation and currency devaluation all help drive the price of the precious metal.