Understanding How Gold Prices Are Determined
Paper currencies have come and gone through the ages but gold has always maintained its value. While cultures have cherished gold for its beauty and viewed it as a symbol of wealth, investors today buy gold to diversify their portfolios, as a hedge against inflation, and for protection against currency devaluation. It’s widely accepted that gold is a good investment, but less is known about how gold prices are determined and what affects the daily price of gold.
Value of the U.S. Dollar
The price of gold is generally inversely related to the value of the United States dollar: a stronger U.S. dollar tends to keep the price of gold lower and more controlled; a weaker U.S. dollar is likely to drive the price of gold higher. This is because people have a tendency to invest and trade in dollars when the dollar is strong. During times of economic uncertainty and when the dollar is weak, however, people prefer to invest in gold, through vehicles such as gold funds or coins.
Who Sets Gold Prices?
Since the first gold rush of 1697 brought gold to London from Brazil, the city has been a bastion of bullion trading. Today, the London Bullion Market Association (LBMA) manages the London Good Delivery List, the only bullion market accreditation accepted across the globe.
For over a century, five companies ran the London Gold Market Fixing Company and set prices through a process conducted by telephone called the “London Gold Fix.” On March 20, 2015, the ICE Benchmark Administration (IBA) took over and replaced the process with an electronic auction system called the LBMA Gold Price. The LBMA owns the rights to the process. Several banks, an oversight committee, and a panel of internal and external chair members make up the IBA.
Twice daily, at 10:30 AM and 3:00 PM UK Time, the IBA publishes the LBMA Gold Price in US dollars, which serves as a benchmark price for gold producers, investors, consumers, and central banks worldwide. The price of gold is adjusted in real-time based on financial evaluations of anonymous auction rounds run every 45 seconds. When all buy and sell orders and imbalances are within 20,000 troy ounces, the price is fixed.
Fact: In 2016, 19.1 million ounces of gold cleared through the London Bullion Market everyday. This is $24 billion in gold traded every 24 hours!
The Six Major Fundamental Factors that Determine Gold and Silver Prices
To grasp this sentence more easily we determined six major fundamental drivers for gold and silver:
1. Price movements of other commodities in combination with global demand for these commodities, an “indirect pricing” of production costs.
2. Global and in particular U.S. inflation, often driven by rising money supply.
3. Trade and growth imbalances against the U.S. and the resulting twin deficits, that might culminate in a “fear factor”.
4. Central banks’ activities like money printing or gold purchases and sales.
5. Real interest rates and in particular the ones in the U.S.: interest rates compared to inflation and wages, that might culminate in “financial repression”.
6. The production/demand/inventory formula in the form of physical demand and supply.
In the short-term, technical support and resistance levels might be more important for gold and silver than for other assets. The reason is the point mentioned above: the whole spectrum of gold fundamentals are so difficult to understand.