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What Drives The Price of Gold, Part II

By Charles Kubach, Mine-Engineer.Com
January 14, 2014

Three primary drivers of the price of gold are:

1. Supply & Demand.

2. The Doomsday Effect.

3. Value of the US Dollar.

Many will say the value of the dollar, best expressed as the USDX, a weighted average against a basket of currencies, is the primary driver of the gold price. However in the last 4 years it has had little effect on the price of gold, long term. As evidenced by the three graphs, Supply and Demand, USDX Index and Price of Gold for 2010, 2011 2012 and 2013, gold steadily increased, despite only one year of falling USDX values, which was 2011. In March of 2011, unemployment fell below 9% and slowly kept dropping. The stock market was improving, to reach a new high in August 2012. (The Doomsday Effect decreasing) Note: All values are the first quarter of each year

Supply and Demand peaked in 2011, but the price of gold kept increasing to nearly $1800/ounce in 2012, as supply and demand dropped off from 4600 tons to 4400 tons, which tended to sustain higher prices for gold. Basic economics in a free market, when there is lower demand, supply contracts so as to not flood the market with products, thereby sustaining prices. From 2012 to 2013 the USDX increased from just below 82 to just below 84, but gold kept steadily increasing, again as demand and supply dropped to 4000 tons.

So it would appear, that during the period from 2010 to 2013, gold prices were driven primarily by supply and demand and a lessoning of the doomsday effect, as the economic outlook of the world improved. The stock market improved from 2012 though 2013, primarily aided by cheap money as the Fed pumped $85 billion a month into the markets, buying back bonds to keep interest rates near zero. This artificial stimulation of the markets accounted for the best year in recent history (2013) for the US stock markets, aided by improved corporate sales and earnings. However without the Fed, this gain would most likely be negligible, with only a modest gain. And, since this artificial long term stimulation of the interest rates by the Fed is a false economic action, there will be a correction to the markets once the economic heroin is withdrawn. After all, we can visit fantasy land, but we must eventually live in reality, and reality always wins.

As investors fled the gold EFT's they dumped tons of gold on the market, which was partially offset by Central Banks buying more gold at lower prices, as gold dipped below $1200/ounce in June 2013. The markets were booming, gaining capital as the doomsday effect slipped into the background and investors shed their gold to put the capital into the markets and reap their record returns for the year. However as the price of gold is currently (Jan 14, 2014) is hovering around $1240/ounce, the top heavy market can not sustain last years incredible gains, aided by the Fed heroin injection, and while they may bounce sideways or gain a bit on the year, there is almost certainly a correction in store for the stock markets in 2014.

So, where does that leave gold? The crystal ball is as bit murky here, but one thing is for certain, gold remains a valid component of any well diversified portfolio, since when the equities are down gold is up, and if one must convert assets into cash during a equity down time, gold always shines profits when sold.

Then there is the China Factor. For many years, India has held the position as the largest consumer of gold, but now China has emerged as another India sized consumer of gold and it is in its infancy. So the demand will increase for gold and will slowly stimulate demand for the yellow metal, as more prosperous Chinese citizens buy the yellow metal and push its value upwards. This year will be interesting, for gold, as it will probably not move much between $1200 per ounce and $1500 per ounce, but I am betting that it will stay much closer to $1500/ounce, as demand increases for gold. This demand will come from Asia and investors getting back into gold, as a portion of their portfolio, to hedge against devalued market risk and as the economy bounces back, jewelry sales should pick up, giving gold another boost.

There are several factors that could cause gold to take off like a rocket, if the Doomsday Effect is fed, from say a China Economic collapse, a US or EU economic setback or some Mid East catastrophe. However, in all probability, gold will have a fair year, bouncing between $1200 and $1500 per ounce and we will see what 2015 brings. In gold we trust, as it is the only financial instrument free of government manipulation, and false economic policies.

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