Why has the price of gold dropped?

Gold is below the US$1200 per ounce mark for the first time in more than two and a half years.  But despite recent global uncertainty, the price of gold has not been going up. Gold is usually a safe haven when there is instability or uncertainty in the market place. So what are the reasons for the drop in this precious metal?

  • Strong US dollar

Strength in the US dollar works against gold. Gold is denominated in US dollars so if the dollar is strong then it will make gold more expensive for international investors. This in turn will drive demand away from gold. If the dollar is rising, then it can mean the American economy is growing stronger. This could lead to the possibility of higher interest rates which can be a negative for the gold price.

  • Strong Economy

The US Federal Reserve have expressed the intention to hike interest rates two more times this year. These interest rate hikes indicate that the US economy has been showing strength. The increase of interest rates is a negative for gold. This is because investors can find better yielding investments elsewhere.  For example, investors would find better returns in riskier stocks which have a higher potential of doing well. When the economy is doing well, shares pay higher dividends, property values will go higher, and savings accounts may pay more.

  • Chinese Demand

China is the world’s largest gold consumer of gold bars and coins. If China’s economy slows down, then gold demand will go down as well, driving down the price. The current trade tensions between China and the US could threaten China’s economy. These trade tensions may affect the strength of domestic and overseas demand of Chinese products. This would in turn impact the Chinese economy and the purchasing power of the Chinese.

  • Confidence in the share market

Although recently we have had market volatility, investors are confident the share market will continue to go up. This is reflected with the strength of the share market and the Dow Jones hitting an all-time high of 26,743.50 on the 21 Sep 2017. The confidence in the market is intertwined with investor’s confidence in the economy. The US Federal Reserve has just increased the cash rate. Another hike is predicted in December and three more in 2019. The Fed is raising these rates as they see an economy growing faster than expected. They are also seeing low unemployment and stable inflation.  A strong economy would benefit the stock market as the potential for companies to increase their earnings is increased. With low unemployment and confidence in the economy, consumers are more likely to purchase more goods and services. This will drive up company revenues. This can translate to higher stock prices and higher dividend payments.

When is the best time to buy gold?

The best time to buy gold is when demand for it is high. When investors are feeling risk adverse, they tend to flock to gold. In times of high unemployment and poor economic growth and ultra-low interest rates, gold will look attractive. This is because other asset classes will look unstable in comparison to gold.  Gold price rose the most during the biggest stock market crashes. When the stock market goes down, gold will often go up. During the precarious period near the GFC between 9 Oct 2007 to 9 Mar 2009 the S & P 500 was down -56.8% but gold was up 25.5%.

Lauren Hua is a private client adviser at Fairmont Equities.

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