Gold hit a five-year low on July 20th. As for all commodities, its price movements are a reflection of supply and demand and expectations about the future.
Gold basically serves two purposes:
1. It is a commodity used in industry (e.g. electronics, jewelry, dentistry)
2. It is a store of value, especially as a protection in turbulent times, for example political upheavals.
But compared to other assets, gold is very different. It generates no income, and it costs even money to store it.
Gold rallied strongly after the financial crisis. Its price peaked in 2011 and ignoring some small rebounds has been falling since (see chart). Ii is approaching $1,000 an ounce and could even drop below that mark if we believe some commentators.
The most obvious reason for gold’s drop is the strong dollar. Gold is priced in dollars, which means that if the American currency goes up, the yellow metal is repriced accordingly. In addition the dollar’s rise is linked to the improving American economy, which will result sooner or later in higher interest rates. Higher interest rates increase the opportunity cost of holding a zero-yield asset; money invested in gold could be earning a return if invested in treasury bills. Strong earnings from stocks have a similar effect, as dividends increase it raises also the opportunity cost for gold.
Supporters of a higher gold price also hinted at China. The ambition to turn the yuan into a reserve currency would help to increase China’s gold stocks in order to make its currency credible in international eyes. China has raised its gold reserves a bit, but they are still very small and as a share of total reserves, China’s gold holdings are falling.
Gold also suffered because of political news. The euro zone’s deal on Greece has reduced the chance of a messy default, and of the break-up of the single currency. The nuclear deal with Iran reduces the risk of war and raises the chances of a broader agreement on other Middle East issues such as Syria.
So the main reason for holding gold is the scale by which central banks are creating money (“quantitative easing”) which will eventually result in disaster in international finance. But at the moment the public confidence in “fiat” money (currency backed by a promise, not precious metal as in former times) is not shattered.