A Easy-to-understand Macro Course
How to invest in Gold? A detailed explanation of the driving forces behind the rise in gold prices.
。It has always played an important role in the international monetary system. During different historical periods, various countries around the world have minted gold coins. Did you know that the world's first gold coin was minted around 560 BC? The direct driving force behind the early colonial activities of Portugal and Spain in the 15th century was to 'seize Gold'. In the 19th century, the discovery of gold mines in California sparked the largest scale of immigration in USA history... Today, let's talk about the charm of Gold based on the macro foundations.
Reviewing the development history of Gold.
Analysis of Gold supply and demand: key driving factors of Gold prices.
Why invest in Gold?
How is Gold priced?
What are the related investment varieties of Gold?
Summary
For a long time, Gold has circulated as currency in many countries—many currencies around the world were pegged to Gold at a fixed price, with the money supply proportional to the amount of Gold, and the Exchange Rates between countries also fixed, a system we call the Gold Standard.
In the 19th century, as the United Kingdom was in a dominant economic and political position and was the first to adopt the Gold Standard, other countries began to follow suit. However, with the outbreak of World War I, the international monetary order fell into chaos, and the Gold Standard became unsuitable. The Great Depression after the war further eroded people's confidence in Banks and paper currency, making hoarding Gold common. At this point, there was an urgent need for a new international system to replace the Gold Standard, leading to the birth of the Bretton Woods system in 1944.
Under the Bretton Woods system, the Exchange Rate of the dollar to Gold was fixed at $35 per ounce, while all other currencies' Exchange Rates against the dollar were adjustable. However, in 1971, in response to inflation in the USA, President Nixon began to reduce the dollar's value against Gold, which ironically stimulated more Gold hoarding. Ultimately, Nixon completely uncoupled the dollar's value from Gold, signaling the end of the Bretton Woods system.
Although Gold's official status in the international monetary system was declared over, due to its scarcity and hedging properties, Gold remains an ideal investment for many.
First, we start with the basic supply and demand framework to introduce the basic situation of Gold.
Production: According to the World Gold Council (WGC), the total amount of Gold mined to date corresponds to a cube with a side length of 22 meters. Since the California Gold Rush in 1848, over 90% of the world's Gold has been extracted. According to Statista, in 2022, the three largest Gold-producing countries were China, Australia, and Russia.
Consumption: India and China were the largest consumers of Gold in 2010, and both countries maintained this position in 2022. Additionally, the USA, Saudi Arabia, Germany, and Turkey are also major consumers of Gold.
Inventory: Gold is measured by weight. The USA has the largest gold reserves in the world, weighing more than 8,000 tons, which accounts for 4% of the 187,200 tons of gold that have been mined to date.
It is well known that Gold is not a Metal that can be mined without limits; due to its relatively limited supply, gold prices are highly sensitive to changes in demand.
According to data from the World Gold Council, in 2022, the massive purchases by central banks, combined with strong buying from retail investors and a slowdown in ETF Outflow, pushed annual demand to a new high in 11 years, with total international Gold demand reaching an astonishing 3,303 tons, making it the strongest year for Gold demand in over a decade.
From the perspective of gold prices, despite facing significant resistance from a strong dollar and rising global interest rates, gold prices still saw an increase in 2022, with the LBMA gold annual average price reaching $1,800 per ounce, setting a historical record.
For some investors, investing in Gold may not only be about appreciating the 'beauty of Gold', but more about Gold's ability to resist inflation and risk—especially during periods of economic volatility. Specifically, Gold has the following advantages:
1. Wearing/Collecting: People’s preference for Gold is based on the metal’s resistance to tarnishing, ductility, and the scarcity that 'symbolizes wealth'. According to data from the World Gold Council, nearly half of all the Gold mined today is made into jewelry, which remains the largest single use of Gold.
2. Wealth Preservation: Over time, inflation reduces the 'real' value of currency. For example, a cup of coffee that costs $4 today may only buy a bottle of mineral water in ten years. Unlike currency, Gold tends to maintain its value, thus, investing in Gold can protect investors' wealth from the effects of inflation.
3. Safe Haven: The value of currency is influenced by national interest rates and monetary supply policies. During periods of economic and geopolitical volatility, the value of currency can fluctuate significantly, whereas Gold does not, thus Gold possesses hedging properties. According to data from the World Gold Council, global gold demand surged by 34% in the first quarter of 2022 due to geopolitical influences.
4. Portfolio Diversification: Gold typically has a lower correlation with traditional financial assets such as Stocks and Bonds. Sometimes, the stock market declines due to high inflation and economic uncertainty, but holding Gold may still yield investment returns. Therefore, incorporating Gold into the portfolio can reduce overall risk exposure.
While the overall risk is lower, investors must be aware that investing in Gold may also carry the risk of wealth loss. This is because, like any asset class, the price of Gold can fluctuate. Factors such as economic data, geopolitical events, and changes in investor sentiment can cause rapid fluctuations in the value of Gold. Furthermore, unlike many Stocks or Bonds, investing in physical Gold does not generate fixed income or dividends.
There are several different ways to invest in Gold, depending on whether the investor wants to invest directly or indirectly.
1. Physical Gold
The first thing that comes to mind may be physical Gold such as jewelry and gold bars, and indeed, this is one of the simplest ways to invest in Gold. Over the past decade, small gold bars and coins have accounted for over half of the global annual gold demand. However, it is worth noting that physical Gold may lack liquidity and investors need to store it securely.
2. Gold Futures
Gold Futures give investors the right to buy or sell Gold at a future price under certain specific terms and are standardized contracts traded on regulated Exchanges. Due to the involvement of many professional investors, the Gold Futures market typically has high liquidity and efficiency, allowing investors to flexibly go long or short on Gold by purchasing Gold Futures, thus Gold Futures are also commonly used by corporate clients for risk management purposes.
3. Gold ETF
Some investors prefer to Hold stocks of companies engaged in Gold mining and refining, and these mining stocks can also be purchased through investing in ETFs and mutual funds. According to Statistics, trading tools like ETFs account for about one-third of Gold investment demand. The prices of Gold ETFs usually track the performance of the underlying Gold spot prices and can be bought and sold on Exchanges like company stocks. As the minimum investment amount is only the price of one share of the ETF, this method is more convenient for small investors than directly owning Gold bars. The average annual expense ratio of these Funds is typically around 0.61%, which is much lower than most mutual funds and the costs and expenses of other investments.
In fact, many investors have been unclear about what the so-called 'Gold price' refers to—whether it is the spot price or the Futures price? There are a variety of prices floating around in the Gold market, but which one is the most important?
The answer is not difficult; let us first conduct a simple classification of Gold price types!
The price of Gold is set through the following three methods:
Spot price: The price at which Gold bars are usually bought and sold is based on the Gold commodity spot price, in other words, the price is determined by the market at the time of purchase and thus varies with supply and demand.
Fixed price: A fixed price is an average Gold price derived from multiple adjustments and tests of the spot price, so it can offset price fluctuations every minute. Fixed prices are set by institutions such as LBMA or COMEX and are priced twice a day, which we will discuss in detail later.
Futures contract price: Gold futures contracts are futures contracts with Gold bars as the underlying asset, and their prices are the agreed prices for buying and selling Gold on a specific date between investors and suppliers. The Gold derivatives market is separate from the actual Gold commodity market, so Futures prices do not completely follow the trends of the Commodity.
In simple terms, the price of Gold is determined by various Banks and supervisory committees and other group members based on the supply and demand situation in the Gold Futures derivatives market to calculate the average spot price and fixed price.
Gold is traded globally for 24 hours, usually priced in US Dollars. According to data from the World Gold Council, around 90% of global Gold trading occurs in the OTC market in London or exchanges such as the New York COMEX or Shanghai Gold Exchange, with the largest trading volume in the global OTC market. Therefore, the OTC market plays an important role in setting Gold prices.
As a result, investors can pay attention to three Indicators of Gold prices:
Spot Price: The spot price of Gold is the most commonly used standard for measuring the current Exchange Rates of Gold, calculated in troy ounces, and changes every few seconds during market trading hours. The Gold spot price is the basis for the fees determined by most gold bar traders.
LBMA Gold Price: The London market accounts for about 70% of the global nominal trading volume, and the London Bullion Market Association (LBMA) is the globally recognized gold and silver market, with its set LBMA Gold Price serving as a reference benchmark for the Gold market. The LBMA Gold Price is priced in US Dollars and has two pricing opportunities daily in the morning and afternoon, operated and managed by the ICE Benchmark Administration (IBA).
COMEX Gold Price: London plays a dominant role in the physical market, but from the perspective of Futures contracts, the largest real-time derivatives market globally is the Chicago Mercantile Exchange (CME or COMEX) and the New York Mercantile Exchange.
What influences Gold prices?
The factors influencing the trend of Gold prices are actually closely related to the logic of investing in Gold mentioned above, which we summarize into the following six factors.
Based on the several factors mentioned in the table, let’s specifically look at two examples that impact Gold prices:
According to a news report by the Financial Times, inflation and currency devaluation have sparked a surge in interest for Gold as a means of wealth preservation. Therefore, central banks in Emerging Markets are buying Gold in large quantities to seek a reduction in dependence on the US Dollar. Among them, the central bank of China has set a historical record for Gold purchases globally, followed closely by Poland and Turkey.
In addition, BNN Bloomberg also reported that, supported by signs that the US interest rate hike cycle is nearing its end, purchases by various central banks, and a series of safe-haven demands, Gold prices rose by about 15% from July 2022 to July 2023.
If there is a feeling of having learned how to analyze Gold from this course, it may be worth following our macro interpretation's "Advanced" column to check the latest market data!
