What Factors Drive the Price of Gold?

Gold has long been a symbol of wealth and financial stability. With its brilliance, this precious metal has fascinated entire civilizations for hundreds of years. No wonder gold, or XAUUSD, as you can find this metal in the forex market, remains important to the global financial system. 

In fact, gold is the most important investment instrument. To prove this, you only need to look at the list of the largest assets by total capitalization. Gold has been steadily on the first position for dozens of years. Experts estimate the value of all metal reserves at 13 trillion dollars, which is phenomenal. And here, of course, it’s important to realize that the price of gold is not just a number, but an indicator shaped by dozens of factors – from economic policy to cultural trends and political upheaval.

In this guide, we will explore the topic of gold pricing and examine what indicators a forex trader in Malaysia who has chosen XAUUSD for their portfolio should pay attention to. Understanding what drives the price of gold will help investors, enthusiasts, and economists make informed decisions in a market as old as civilization itself. Join us as we explore the key drivers of the gold standard in the Forex market, prepared by the JustMarkets team for our readers in Malaysia and beyond.

Key Takeaways:

• Actions by central banks can directly impact gold prices, with increased purchasing often driving prices up.
• High demand in jewelry making and industrial uses often leads to a rise in gold prices, while decreased demand can lower them.
• During times of uncertainty, gold prices typically increase as it is considered a safer investment.
• In countries with strong cultural ties to gold, increased demand during festive or wedding seasons can increase prices.
• A weaker dollar generally makes gold cheaper for foreign investors, potentially increasing demand and increasing prices.
• Stricter mining regulations and environmental concerns can reduce supply, leading to higher gold prices.
• The speculative interest in gold and broader market trends can significantly sway prices, often driven by sentiment and investment flows.

Reason #1: Central Bank Policies and Economic Factors

Central banks are like the wizards behind the curtain in the gold market. They wield significant power, and their policies can send ripples across the global financial landscape. For instance, when central banks like the Federal Reserve or Bank Negara Malaysia tweak interest rates, print more money, or intervene in the Forex market, they indirectly impact the price of gold.

Central banks hold vast reserves of gold. A sudden move to increase or decrease these reserves can cause substantial fluctuations in gold prices. During times of economic uncertainty, such as financial crises or geopolitical tensions, central banks often turn to gold as a haven. They adjust monetary policies, such as lowering interest rates or implementing quantitative easing, which can lead to inflation. As inflation rises, the value of paper currency declines, making gold more attractive as a hedge against inflation. Conversely, gold prices tend to fall when central banks tighten monetary policy, raise interest rates, or strengthen their national currencies.

We have a full guide on Central Banks’ influence on the Forex market. You may read it here.

There are some interesting examples that you may remember since they happened relatively recently:

U.S. Federal Reserve Quantitative Easing (QE)

During the global financial crisis in 2008 and later during the COVID-19 pandemic in 2020, the U.S. Federal Reserve implemented quantitative easing—a policy of buying securities to inject money into the economy. These actions led to a decrease in interest rates and an increase in inflationary expectations. As a result, investors turned to gold as a hedge against potential inflation, driving up its price.

European Central Bank’s Interest Rate Decisions

In 2011, in response to the Eurozone debt crisis, the European Central Bank (ECB) lowered interest rates to stimulate economic growth. Lower interest rates decreased the yield on euro-denominated assets, making gold, which doesn’t yield interest, a more attractive investment. This contributed to the rise in gold prices on Forex during that period.

Bank of England’s Monetary Policy after Brexit

Following the Brexit vote in 2016, the Bank of England cut interest rates to combat economic uncertainty. This policy shift led to a weakening of the British pound, making gold priced in pounds cheaper for investors holding other currencies. Thus increasing demand and pushing up gold prices in GBP terms.

Reason #2: Market Dynamics 

The price of gold is also significantly influenced by the basic principles of market dynamics: supply and demand. These factors can vary dramatically, causing substantial fluctuations in gold prices. Understanding these dynamics offers traders and investors crucial insights into potential Forex market movements. Here’s how they impact gold pricing:

Supply Factors:

• Mining Production

Gold mining output directly affects supply levels. Major gold-producing countries like China, Australia, and Russia play significant roles in setting global supply. A decrease in production, often due to geopolitical issues or environmental regulations, can tighten supply and push prices up.

• Recycling

Gold is continuously recycled, with old jewelry and electronic components often melted down to create new supplies. The recycling rate can increase when prices are high, slightly offsetting demand pressures.

• Central Bank Sales and Purchases

Historically, central banks have been significant holders of gold, and their market activities can influence prices. For instance, net purchases by central banks (adding gold to reserves) reduce supply in the Forex market and can lead to higher prices.

Demand Factors:

• Investment Demand

Investment in gold via bullion, coins, or gold-backed ETFs can vary significantly based on economic indicators and market sentiment. During times of economic uncertainty or inflation, investment demand for gold increases as it is seen as a safe-haven asset.

• Jewelry and Industrial Use

Gold’s physical properties make it valuable in industries such as electronics and dentistry. However, the largest demand comes from jewelry, which consumes about 50% of all gold mined. Economic growth in large markets like India and China has a profound effect, as cultural and economic factors boost demand.

• Technological Advancements

Innovations in technology can open new uses for gold or improve mining efficiencies, affecting both supply and demand.

Indirectly but significantly, the gold price is driven by market sentiments caused by global economic conditions, geopolitical tensions, and changes in financial markets, which play a crucial role. Speculation in the futures markets can also lead to rapid price changes, as traders react to global news events and economic forecasts.

The interplay between supply and demand is complex and often results in cyclical effects on gold prices. For example, high prices might increase mining and recycling efforts, temporarily boosting supply, which could moderate prices if demand doesn’t keep pace.

Reason #3: Geopolitical and Economic Uncertainty 

Geopolitical and economic uncertainties are significant drivers of gold prices. When global stability is threatened by economic crises, political strife, or unforeseen events, investors often turn to gold as a safe haven. This precious metal is widely regarded as a store of value that can withstand financial turbulence better than other assets.

Consider the impact of a hypothetical large-scale war in the Middle East. Such a conflict would likely lead to significant economic disruptions, affecting oil prices and global markets. In this scenario, the price of gold would probably surge as investors seek security amidst the uncertainty. Historical precedents, such as the price movements during the Gulf War or recent tensions between major powers, have shown similar patterns.

In this context, we may also discuss economic crises. Economic crises, such as the global financial meltdown in 2008 or the COVID-19 pandemic’s impact on economies worldwide in 2020, have similarly driven investors towards gold. During these times, the weaknesses of other investments become stark, and gold’s intrinsic value shines through as a beacon of stability.

So, if you aim to consistently trade XAUUSD in the Forex market, it’s important to stay abreast of the world political situation. As people say, if you don’t do politics, politics will do you.

Reason #4: Environmental and Regulatory Factors

Stricter environmental laws can limit where and how gold mining companies operate, potentially reducing the global supply of gold. For instance, regulations that protect ecosystems from the adverse effects of mining may restrict operations in ecologically sensitive areas, leading to decreased production outputs.

Compliance with environmental regulations often requires significant investment from mining companies. These investments include upgrading equipment to reduce emissions, implementing more sophisticated waste management systems, or rehabilitating mining sites post-extraction. The increased operational costs can lead to higher gold prices as miners seek to maintain profitability.

We can make up a very simple but clear example. Consider the effects of a new regulation implemented by a major gold-producing country, which mandates a significant reduction in water pollution from mining activities. This regulation could lead to temporary shutdowns or slowdowns in production as companies adjust their processes to comply, consequently reducing the immediate supply of gold and pushing prices up. Of course, reasons might differ, and we can’t predict everything, but it would be nice for a trader to know about major regulation changes.

It’s Time to Trade Gold!

Gold prices are influenced by a complex interplay of factors ranging from market dynamics and geopolitical tensions to environmental regulations and economic conditions. Each of these elements contributes uniquely to the fluctuating prices of gold, making it a multifaceted asset to understand and predict. For investors, recognizing how these diverse forces interact is crucial for making informed decisions and optimizing investment strategies in the gold market.

For those looking to invest in gold, staying informed about these driving factors is essential. Monitoring market trends, geopolitical events, and regulatory changes can help you better navigate the uncertainties of the gold market. 

For further reading, we recommend our guide on the Best Time to Trade Gold in Malaysia.