Financial markets - 07/2020

What are the drivers behind gold prices today? A Goldilocks scenario

Laurence De Munter

Gold prices are back at levels not seen since 2012. Whilst this precious metal is quite volatile, it does play an important role in a diversified investment portfolio as it protects against defaults, inflation and geopolitical events. What are the drivers behind gold prices today? Are they here to stay or is it time to take profit?

The highest level recorded was on the 5th of September 2011 where the precious metal reached USD 1,900 per Ounce. This was during the European debt crisis and S&P’s downgrade of the United States’ credit rating. Today’s gold prices are close to their all-time highs and analysts expect gold prices to keep climbing.

What drives gold prices?

Similar to other commodities, this precious metal is impacted by supply and demand. With gold, it is in particular the demand side that determinates the price. Buyers of gold are Central Banks, companies who need it in their production process as well as individuals. Various factors impact the individual demand for gold and the importance of these factors change over time.

Gold prices usually rise during geopolitical crisis. Indeed, gold acts as a safe haven during times of high uncertainty as we are experiencing today. The fear of the COVID-19 virus as well as the economic impact from lockdowns have led to prices not seen since 2012. In graph 1, you can see how gold prices rise sharply during times of major crises such as the banking crisis in 2008. The key reason is that gold doesn’t default and hence offers a safe place for storage.

graph-gold-as-safe-haven

 

One of gold’s biggest disadvantage is that it provides no income unlike bonds or stocks. However this has become increasingly irrelevant as government bonds have low or even negative yields. If assets with default risk pay you nothing in real terms, then better to hold gold.

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Gold is money, everything else is credit.


John Pierpont Morgan
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