Our Insights

About personal finance, investments and markets.
August 30, 2016

What drives the price of gold?

Gold does not generate any income like bonds (interest), equities (dividends) or properties (rent) which makes it difficult to value. However, that doesn’t mean that we cannot explain what moves gold prices. In fact, there is one factor that can explain the majority of changes in gold prices!

Real bond yields are the critical driver

There are many factors that influence the price of gold such as mining volume, production costs, central bank buying/selling and jewelry demand. While they all play a role, the key driver are real yields: because gold provides no yield, it is implicitly a hedge on inflation rising above nominal rates. In other words, it is a hedge against the real bond yields falling. When real bond yields decline, then the price of gold goes up and vice versa. The following chart shows how closely the real yield on US 10 year TIPS (treasury inflation protected securities) moves together with the inverted price of gold.

1d

The concept of opportunity costs is another way of looking at it. When the real yields on inflation protected bonds declines, than the opportunity cost of owning gold drops and investors would be more willing to pay a higher price for gold.

To show how closely real yields on TIPS move with the gold price, we can plot the correlation between both. A correlation of 0 means both move independantly of each other while a correlation of 1 means they have a perfect positive relationship. Over the last 10 years, the correlation between gold and real yields was 75%. We therefore believe that real yields are the single most important factor. The current level of real yields can be found at the website of the Federal Reserve Bank of St. Louis, FRED.

2d

The bottom line

Investors should be aware of the relationship between gold and real yields because it has important implications for how they think about the role of gold.

In our next newsletter, we will try to analyze whether gold is actually an efficient part of a portfolio or if there are better alternatives in an asset-allocation framework.

Source:

https://fred.stlouisfed.org/series/DFII10

https://www.pimco.com/insights/viewpoints/viewpoints/demystifying-gold-prices

Please read our Terms of Use.