It is important to distinguish the forces and players that drive gold prices in the short term — measured in days, weeks and sometimes months — from those that determine the long-run trend and average price over many years.
In the short term, the key players tend to be institutional traders and speculators — the trading desks at banks, hedge funds and other financial firms — who operate principally in “leveraged” futures and derivative markets.
With little cash down, these are the folks who are most responsible for gold’s sometimes extreme price volatility, often with big ups and downs. Rather than allowing long-term forces to push gold prices up at a more measured rate, these traders were responsible for driving the gold price sharply higher last summer to its all-time high near $1,924 on Sept. 6, and then driving it back down to about $1,525.
What motivates these traders is the necessity to make short-term trading profits. They have no lasting long-term interest or allegiance to gold as an inflation hedge, portfolio diversifier or insurance policy against economic risk.
While their collective trading volume and the size of their individual trades may, at times, be huge enough to move the price by more than a few dollars, they rarely operate in the physical market where bullion bars are actually bought and sold. And, it is in the physical market where the long-run average price over many years is determined. Here, the key players are:
➤ Retail and institutional investors that hold gold for protection against currency depreciation and debasement, domestic price inflation, and an assortment of political, economic and financial risks.
➤ Central banks that hold gold as an official reserve asset whose value, unlike foreign currency reserves, is independent of sovereign issuer risk.
➤ Jewelry consumers, who buy for some emotional “feel good” needs and desires, or as a convenient and traditional form of gold investment (in countries like India and China).
➤ And mining companies who regularly add new supply to the market — but with total quantities changing little from year to year.
It is simply the supply and demand for physical metal by these market participants that will determine the price of gold in the years ahead.