The gold standard: gold price and hedging against inflation

What drives the gold price?

Here are the top five drivers of the gold price:

1. Value of the USD
2. Market volatility
3. Gold production
4. Reserves
5. Jewellery demand

In addition, environmental factors such as inflation rates, government changes, governmental scandals, elections and wars (which create market volatility) also affect the gold price.

Value of the USD

The gold price is related to the value of the United States dollar because the metal is dollar-denominated. A stronger US dollar tends to keep the price of gold lower and more controlled, while a weaker USD will likely drive the gold price higher due to increasing demand (as more gold can be purchased when the currency is weaker).

Market volatility

During uncertain economic times, such as recession, more people tend to gravitate towards gold because of its enduring value. Described as a ‘safe haven’ for traders during turbulent times, when the return on bonds, equities and real estate fall, the interest in gold positions can increase, driving up its price.

Gold production

China, South Africa, the US, Australia, Russia and Peru are major gold mining players. The world's gold production affects the price of the commodity, which is another example of supply meeting demand.

Gold mining production has not changed significantly since 2016 as the ‘easy gold’ has already been mined, therefore miners need to dig deeper to access quality gold. This brings additional problems such as leaving miners exposed to additional hazards and worsening environmental impact.

Consequently, it now costs more to mine less gold. All this adds to gold mining production costs resulting in higher gold prices.

In 2021, gold demand bounced back from Covid-19-induced losses in 2020, to reach 4.02lt.

Reserves

Government vaults and central banks hold paper currencies and gold in reserve and when central banks diversify away from paper currencies and into gold, it results in increasing prices. Many of the world's nations have reserves that comprise primarily of this shiny commodity.

Bloomberg reports that global central banks have bought the most gold since the US abandoned the gold standard in 1971. Turkey was the largest gold purchaser in 2019 followed by Russia, Poland and China. Governments bought a total of 650 tonnes of gold in 2019, down from 656 tonnes bought the previous year.

Jewellery demand

In 2019, jewellery accounted for about half of the gold demand, which was more than 4400 tonnes. India, China and the US are significant consumers of gold for jewellery.

As a desirable commodity, gold is not only pursued for investment purposes and to make jewellery, 7.5% of demand is used for technology to manufacture electronic and medical devices such as GPS units and stents.

Investment demand – especially from exchange traded funds (ETFs) – also pushes an underlying need. Gold bar and coin investment reached an eight-year high in 2021.

Learn how to trade or invest in gold with us

Is the gold price a hedge against inflation?

The gold price is considered a hedge against inflation, as many traders and investors opt to get exposure to it to protect their capital against value erosion, which arises from an increase in general prices.

Gold prices are related to the value of the US dollar (USD) because gold is dollar denominated. Therefore, a stronger USD keeps the price of gold lower and more controlled, while a weaker USD drives the gold price higher due to increasing demand. Therefore, more gold can be purchased when the dollar is weaker.

Exposure to gold reduces the risk of an asset’s adverse price movement and consists of taking an opposite position in a related security. Gold and inflation are not only linked, but this precious metal also protects against economic events like currency devaluation and provides a safety net during periods of political instability.

The golden star: how has gold performed over the past 50 years?

Inflation is one of the most discussed economic metrics in financial markets.

The line graph below shows that gold prices in the past 50 years rose in relationship to the UK’s inflation rate, which is why many individuals have chosen – and continue to choose – gold as an inflation hedge.

The golden way to hedge against inflation

Trading

1. Create account or log in and go to our platform to start trading
2. Choose CFDs and search for your opportunity
3. Select ‘buy’ to go long or ‘sell’ to go short
4. Set your position size and take steps to manage your risk
5. Open and monitor your position

How to trade gold without owning it

Traders don’t typically have Fort Knox (or similar facilities) in their property portfolios; therefore many appreciate that holding heavy, gold bullion is a difficult (and costly) process.

The good news is that there are ways to trade gold without physically holding it. You can trade price movements (of gold itself or gold company shares). Learn more about each method below.

• CFD trading

CFDs

With us, you can trade contracts for difference (CFDs) on the spot, via gold options or futures.

Steps to trading gold via CFDs

1. Learn what CFD trading is
2. Create and fund a CFD trading account
3. Choose your gold market and timeframe
4. Decide whether to buy or sell
5. Set your stops and limits
6. Open and monitor

The price of gold and inflation summed up

• The gold price is mainly driven by the value of the USD, market volatility, gold production, reserves, and jewellery demand
• Gold is considered a hedge against inflation, as many traders and investors opt to get exposure to it to protect their capital against value erosion
• Gold and inflation are not only linked, but this precious metal also protects against economic events like currency devaluation and provides a safety net during periods of political instability.
• You can trade gold and gold stocks with us, without owning them via CFD trading

Sources

¹ Kitco, 2021