Hidden Forces That Affect Gold's Value

• Ronnie Stöferle, managing partner at Lichtenstein-based Incrementum, discusses his extensive work on gold economics, including his annual report "In Gold We Trust," and books on the Austrian School of Economics.
• Stöferle notes a divergence between market sentiment and the actual performance of gold, pointing out that gold has been performing well in various currencies despite rising real interest rates.
• He discusses the shift in control over the gold price from Western to Eastern markets, specifically mentioning increased buying activities in Mumbai, Shanghai, and Dubai. Central bank buying, particularly from oil-rich nations, has also increased.
• Stöferle emphasizes the importance of the stock-to-flow ratio in gold, arguing it to be a strong indicator of gold's value. He mentions that gold production cannot immediately rise even if gold prices soar, making it a stable asset.
• He touches on challenges and opportunities for the gold industry, such as the increasing role of ESG (Environmental, Social, Governance) considerations and gold's role in the Green Revolution. He also discusses generalist investors' hesitancy to enter the gold market.

Gold: The Shiny Metal with a Complicated Story

Gold has captivated humanity for thousands of years. Its alluring color and luster, combined with its malleability, ductility and resistance to corrosion, have made it a highly valued and coveted metal throughout history.

In the modern financial world, gold remains an important asset. Its price is influenced by a variety of complex and intertwined factors, ranging from fundamental supply and demand dynamics to more esoteric elements like cultural affinity and geopolitical uncertainty. For investors, understanding what moves the gold market is crucial to making informed decisions.

Supply and Demand Fundamentals

At its core, the price of gold is influenced by basic supply and demand forces. How much new gold is being mined versus how much is being bought and sold in a given period impacts whether the metal becomes more or less scarce, affecting its market value.

On the supply side, annual gold production from mining has been remarkably consistent, averaging around 3,000 metric tons per year over the past decade. Output did hit a record high of 3,545 tons in 2018 due to several new large-scale mines coming online, but COVID-related disruptions caused production to fall 6% in 2020. Supply is relatively stable because big increases or decreases in mine output do not happen quickly. New major gold discoveries are rare, and it takes many years to develop a mine. While small changes in production occur annually, game-changing shifts in global supply are uncommon.

Demand for gold, on the other hand, can vary more substantially. It comes from four primary sources: jewellery fabrication, investment (bars, coins, ETFs), central bank purchases, and technology/industrial uses. Jewellery makes up the lion’s share of demand, consistently accounting for 50-60% annually. But investor activity, driven by macroeconomic and market forces explored later in this article, is often the swing factor that tilts supply/demand dynamics one way or the other. When economic uncertainty rises, investors rush to gold, boosting demand. In more upbeat times, interest wanes and jewellery demand predominates.

If demand outpaces new mine supply in a given year, the market typically sees deficits where gold is taken out of inventories to meet the excess demand. The drawdown of stocks pushes the gold price higher. The opposite occurs when supply exceeds demand – inventory builds up, putting downward pressure on prices. These shifting supply/demand balances are a key driver of both short and long-term moves in the gold price.

Influences on Investment Demand

Since investment demand is the most variable factor in gold’s supply/demand equation, what drives it merits further inspection.

There are two primary influences on investment demand for gold:

1. Economic/Market Conditions: When markets and/or economies face increased volatility or uncertainty, investors often flock to gold as a safe haven asset. It serves as a hedge against more speculative investments like stocks. Factors like recessions, periods of high inflation, currency crises, and stock market crashes tend to stoke demand.
2. Opportunity Cost: The “opportunity cost” of holding gold is essentially the returns an investor misses out on by choosing it over other assets. When returns on stocks, bonds and other investments look more favorable than gold, its appeal dims for investors. Rising interest rates in particular boost opportunity costs and weigh on gold.

Economic and market turbulence tend to push investors toward gold, while upbeat conditions that provide attractive returns elsewhere often cause them to rotate away from it. These factors feed heavily into short and medium-term fluctuations in demand.

Longer-term shifts in global investment preferences also impact gold. For example, the rise of emerging market middle classes, especially in India and China, has boosted jewellery and investment demand over the past two decades. Increased central bank buying has also provided more constant demand. On the flip side, some argue that digital assets like Bitcoin might divert some investor dollars away from gold, but the jury is still out.

Momentum and Sentiment

Like other assets, momentum and general sentiment often fuel short-term swings in the gold price – sometimes more than underlying fundamentals.

Gold accelerates higher when it is rallying as investors don’t want to miss the ride. The same happens in reverse when prices are falling. Media coverage also impacts sentiment. When gold is hot, media attention intensifies public interest, which can feed a frenzied surge. Sentiment applies not just to those investing in gold, but also participants trading it. Speculators with no intention of actually holding physical gold sometimes engage in high-volume trading for short-term profits, and their transactions can move markets.

Geopolitical and Economic Uncertainty

Gold’s status as a safe haven asset also makes it subject to geopolitical and economic uncertainty. War, political turmoil, trade conflicts, currency crises, and similar instability often spur demand for gold among investors. They view it as protection from rainy days.

This reaction has played out many times over the decades. For example, gold prices surged to all-time highs near $2,000 per ounce in mid-2020 partly due to heightened geopolitical tensions like the U.S.-China trade war. It also benefited from massive economic stimulus programs that stoked inflation fears. More recently in 2022, gold rallied back above $2,000 on Russia’s invasion of Ukraine and the uncertainties it unleashed. Investors flocked to gold’s relative safety.

While such conflicts and crises drive sharp short-term demand spikes, prolonged economic uncertainty and dollar weakness can fuel sustained bull markets in gold. That was the case in the 2000s as the dot-com bubble, Great Recession, and policy responses impacted markets and investor psychology over many years.

Cultural Affinity

In nations like India and China, gold carries deep cultural significance. It is intertwined with weddings, gifts, and holidays. This drives steady jewelry demand that underpins a higher domestic gold price in those countries. When hundreds of millions buy even small amounts of gold for cultural purposes, it adds up.

While Western investors tend to see gold mainly as a financial asset, many in India and across Asia view it as integral to celebrations of life, love, and prosperity. This cultural affinity is responsible for a large chunk of annual consumer demand. It may evolve with time as attitudes and economics shift, but remains an important factor underpinning gold’s broader appeal.

The U.S. Dollar and Real Interest Rates

Gold’s arch-nemesis is the U.S. dollar. That is because gold is internationally priced in dollars – essentially a currency exchange rate. When the dollar strengthens relative to other currencies, it makes gold more expensive for foreign buyers. That dampens demand and puts downward pressure on gold prices. The opposite occurs when the greenback weakens. Overseas buyers can exchange their currencies for more dollars per ounce of gold, boosting demand. A weaker dollar is rocket fuel for gold.

Another key metric is real interest rates, which account for the impacts of inflation. As a non-yield producing asset, gold becomes more attractive when real rates turn negative – that is, when inflation exceeds Treasury yields. This happened through much of the 2010s as easy Fed policy kept rates low while inflation crept higher. Negative real rates sink the dollar’s relative value, boosting gold.

Rising real interest rates do the opposite, strengthening the dollar and increasing the opportunity cost of holding zero-yield gold. That dynamic has pressured gold at times in 2022 as the Fed hiked rates to combat high inflation. If real rates peak and head lower again, it could reinvigorate gold.

The Fed and Monetary Policy

The U.S. Federal Reserve’s monetary policy decisions significantly influence gold prices by impacting two key variables – real interest rates and the dollar.

Dovish monetary policy that keeps interest rates low and expands money supply through quantitative easing or bond purchases is traditionally bullish for gold. This type of accommodative policy prevailed for much of the 2010s after the Great Recession, helping fuel gold’s bull run to record highs above $1,900 per ounce in 2011.

Conversely, hawkish Fed policy that raises interest rates and tightens the money supply tends to weigh on gold. Higher rates boost the opportunity cost of holding non-yielding gold. Tightening also strengthens the dollar, pressuring gold. We saw this dynamic play out in 2013 when the Fed first hinted it would start tapering easy policy. Gold plunged that year as markets anticipated higher rates. An actual tightening cycle starting in 2015 drove gold down to $1,050 by the end of 2015.

However, gold prices often bottom near the beginning of Fed tightening cycles as markets fully price in expectations of higher rates. Once the tightening becomes well-telegraphed, gold stabilizes as uncertainty diminishes. The inflection point for the next bull run comes when the tightening cycle peaks. As the Fed stops hiking and prepares to eventually cut rates again, markets start pricing in a return to looser monetary policy. This sparked sharp recoveries for gold in 2016 and 2019 after the Fed paused rate hikes.

Markets are forward-looking, so gold responds more to expectations of Fed easing or tightening rather than current policy. If inflation forces the Fed to reverse course sooner than expected, it could drive the next major rally in gold. The interplay between Fed policy, interest rates, inflation expectations, and the dollar is complex. But monetary policy shifts are a crucial variable for the long-term gold price outlook. Investors need to understand these relationships to intelligently analyze gold’s direction.

Positioning and Technical Factors

In the short term, trends in investor and speculator positions in the futures market significantly impact gold prices.

The Commodity Futures Trading Commission (CFTC) releases weekly data on overall net long and short positions held by different classes of traders. When large speculators like hedge funds and money managers boost their net long exposure, it signals rising bullish sentiment that can accelerate gold’s ascent. For example, in mid-2020 as gold rallied toward its record high, managed money net long positions reached an extreme 29-year high. This overcrowded long positioning ultimately contributed to gold’s pullback later that year. More recently in 2021, large speculators flipped to holding a net short position, amplifying gold’s decline.

Following the lead of these influential futures traders provides insights into shifting sentiment and near-term outlooks for gold. Their collective positioning via CFTC data reveals much about gold's potential direction.

In addition to futures positioning, technical chart factors often impact short-term gold price action, especially in the absence of major fundamental news. Key levels like round numbers ($1,500, $2,000) or previous highs and lows mark psychological thresholds that can trigger buying or selling when breached. Short-term traders also closely watch trendlines and moving averages. For example, a break below gold’s 50-day moving average might spur momentum selling. Moving average crossovers, bullish chart patterns like “golden crosses”, and overbought/oversold indicators also generate trading signals.

While longer-term investors should not obsess over daily technical gyrations, being aware of key positioning dynamics and chart levels helps explain frequent short-term swings in the gold price. Zooming out to the bigger picture, fundamental supply/demand factors take over as the key driver. But positioning and technicals often justify daily price action.

Key Takeaways for Investors

Now that we have explored the varied mix of factors that influence gold, let’s summarize some key implications for investors:

1. Fundamentals are crucial over the long run - Gold’s upside is driven by inflation, economic crises, and dollar weakness. The downside comes from real rate hikes, dollar strength, and upbeat growth. Ultimately, fundamentals prevail.
2. Shorter-term volatility is common - Headline events, positioning shifts, and technical levels often cause large daily swings. Don't obsess over them.
3. Patience and discipline pay off - Timing gold's next move is exceedingly difficult. Stay focused on the long game rather than short-term noise.
4. Allocate based on your objectives – Don’t overweight gold hoping to hit the jackpot overnight. See it as portfolio insurance against economic turmoil.
5. Consider dollar-cost averaging – Given gold's volatility, building a position via regular fixed-dollar purchases can reduce timing risks.

Gold’s value is influenced by an array of complex and interrelated factors. While sometimes volatile and difficult to predict, gold has proven its merit as a long-term store of value for centuries. Prudent investors allocate a slice of their portfolios to gold as a diversifier and hedge against economic and market uncertainties.

By understanding what impacts gold prices and not getting distracted by day-to-day noise, investors can utilize gold effectively within the context of their broader investment strategies. With patience and discipline, the magical metal can play a valuable role in portfolio performance over time.

• In Gold We Trust report – English
• Compact Version – English
• Slidedeck IGWT 23

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Gold Companies to Watch

First Mining Gold‍

First Mining Gold is a Canadian gold development company focused on advancing its flagship Springpole Gold Project in Ontario, one of the largest undeveloped gold projects in Canada, and the recently acquired Duparquet Gold Project in Quebec, a top 20 Canadian gold asset. The company also has interests in several partnership assets including the Pickle Crow project in Ontario with Auteco Minerals, the Hope Brook project in Newfoundland with Big Ridge Gold, and is the largest shareholder of Treasury Metals which is advancing the Goliath Gold Complex in Ontario. First Mining was founded in 2015 by Keith Neumeyer, the founding President and CEO of First Majestic Silver Corp.

Karora Resources‍

Karora Resources is a growing gold and nickel producer in Western Australia with its main assets being the Beta Hunt mine, Higginsville operations, and Lakewood Mill located near Kalgoorlie. With over 1,900 km of highly prospective land, Karora produced a record 133,836 ounces of gold in 2022 and over 80,000 ounces in the first half of 2023, aiming to reach 170,000-195,000 ounces by 2024. A leader in ESG, Karora achieved carbon neutrality in the past two years. The company believes growing to 200,000 ounces of annual production will re-rate its valuation to the next tier of gold producers, and Karora is debt-free and well-positioned to self-fund growth from operational cash flow.

Treasury Metals‍

Treasury Metals is a Canadian gold exploration and development company focused on advancing its Goliath Gold Complex in Northwestern Ontario, which contains 2.1 million ounces of measured and indicated resources and 1.3 million ounces of proven and probable reserves. The project benefits from proximity to infrastructure like roads, power, rail, and communities. Treasury also has early-stage exploration projects in Ontario, including Gold Rock and a joint venture at Weebigee-Sandy Lake. The company aims to foster open dialogue with regional communities and Indigenous Nations to create sustainable economic opportunities, safe workplaces, social value, and community well-being.

‍Signal Gold‍

Signal Gold is a TSX and OTCQX-listed gold mining company operating in Nova Scotia and Newfoundland. The company is advancing the high-grade Goldboro Gold Project and operates the Point Rousse mine, mill, tailings facility, and port. Signal Gold also owns 15,000 hectares near the past-producing Nugget Pond Mine. The company's main goal is to produce 150,000 ounces of gold per year within the next 5 years.

Elemental Altus Royalties

Elemental Altus Royalties is a rapidly growing gold royalty company providing investors with de-risked, quality investments in top-tier mining companies across four continents. As the only emerging royalty company with material revenue and sustained organic growth, Elemental Altus is backed by the successful Discovery Group and offers a unique combination of innovation, global expertise, and entrepreneurial spirit to conduct complex international transactions in the mining sector.