Gold has been a star performer so far this year. It broke through US$2,500 an ounce multiple times in August and reached new highs. As of mid-September, gold had achieved a total return of 25.88% year to date, raising the question of why is gold so expensive?

What drives the price of gold?

Gold is a store of value, meaning nearly every tonne of the precious metal that has ever been extracted is still in circulation – minus some stored gold that has been lost to antiquity through shipwrecks or concealment.

Gold from mining is relatively more sensitive to the cost of production. A bulk material like iron ore requires high initial capital outlays and can continue operating for years, even if pricing means operating at a loss for an extended period. However, gold mines can be switched on and off with greater ease if there is a sustained change in gold price direction.

On the demand side, central banks and consumers are the prime buyers, with industrial demand contributing but with a muted impact.

In 2022, Central Banks demand for gold totalled 1,081 metric tonnes. This is the highest demand from Central Banks in history and double the average annual Central Bank demand for gold in the prior 10 years.¹

From a consumer viewpoint, different parts of the world impact demand depending on local drivers. Western countries tend to be influenced by levels of wealth, as value added gold is purchased through jewellery or trinkets. In Asia, consumer demand is more about a store of value, with gold typically traded based on weight.

Investors also have an impact, with global ETF’s now holding more than 3000 tonnes of physical gold or the equivalent of a large central bank like Italy or France, according to the World Gold Council.

Geopolitical risk concerns have also been behind the most recent run in gold prices. Regional wars, geopolitical tensions between superpowers and elections around the globe have all added to volatility and led to a flight to safe-haven assets.

Traditional drivers of gold price

From an investor’s viewpoint, it should be noted that two key drivers of gold pricing are currently in abeyance.

Traditionally, changes in the US dollar and a shift in real yields had a significant impact on gold. Real yield is measured by the cash rate minus inflation.

As gold is generally denominated in US dollars, the two tend to have an inverse relationship. A strengthening greenback tends to drive prices lower. A rising US dollar also makes it more expensive for international buyers.

As a non-yielding asset, gold becomes less attractive when real yields are high. This relationship had existed for a long time. However more recently, gold prices have been resilient despite US real yields edging higher. It is likely that the impact of real yields on gold prices has been offset by other, more dominant factors such as robust demand from retail consumers and continued central bank purchases.

One possible explanation could be that markets are forward looking and gold has been rallying in anticipation of potential interest rate cuts from the US Federal Reserve later this year. This makes gold more attractive compared to interest baring assets, as lower rates reduce the opportunity cost of holding non-yielding assets like gold.

Also, if real yields have peaked, this could combine with anticipated future weakness in the US dollar to create a potential tailwind for a rising gold price.

Gold in a portfolio 

Traditionally, gold has exhibited low or negative correlation with equities and other risk assets. For example, from 2014 to 2024, gold’s correlation with major indices including S&P500, Nasdaq 100, and Euro Stoxx 50 was 0.07, 0.28, and -0.102 respectively.

This is because gold is viewed as a safe-haven asset and a hedge against a wide range of situations, such as geopolitical conflicts, inflation, economic recession, or debt crisis. Gold offers diversification and the potential to decrease overall portfolio volatility.

Options for investing in Gold

It is important to distinguish between investing in physical gold and listed gold producers.

If you’re seeking exposure to gold, you can buy gold bullion, however, investing in an ETF backed by physical gold is generally more convenient.  Apart from reducing the cost of storing physical gold, these ETFs are typically easy to transact, have high liquidity, and investment performance is usually reflected in the gold price.

Investing in gold producers can be impacted by multiple factors in addition to the gold price, such as mine development and operations, hedging positions and overall market direction.

However, companies may also offer growth opportunities through mergers and acquisitions, new mine discoveries and development or peer outperformance, meaning it’s a weighted decision on how you want to introduce gold into your portfolio.

Of course, you can have a direct gold exposure through a gold backed ETF and still hold a gold producing company as part of your equities strategy. The main thing to ensure is that you are comfortable with the level of your gold exposure and associated risk within your portfolio.

Conclusion

Potential cuts in US interest rates and ongoing geopolitical tensions are short term tailwinds for gold prices. However, further out as interest rates stabilise and geopolitical risks potentially lessen, those tailwinds could change into headwinds.

Whatever the outcome, gold has earned its position within a diversified long term investment portfolio.

To discover more call 1300 683106 or email us on investordesk@nab.com.au

¹ https://www.gold.org/goldhub/data/gold-demand-by-country

The information contained in this article is gathered from multiple sources believed to be reliable as at September 2024 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. NAB does not guarantee the accuracy or reliability of any information in this article which is stated or provided by a third party. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2024 NAB Private Wealth is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686.