The Factors Driving Gold to Record Highs
In this cheat sheet we describe the major, long-term drivers pushing gold to record highs.
1. US trade policy
The major driver of gold’s price at the moment is US trade (and to a lesser extent foreign) policy. The decoupling by the US and its major trading partners, particularly China, has forced countries with major trade surpluses with the United States to reconsider where they park all the US Dollars they make by selling their products to the United States. To illustrate, when a US business or consumer buys something from a Chinese company, the US receives new goods and China receives US Dollars. Because China sells more stuff to the US than the US sells to China, it ends up with more US Dollars or “reserves”. In the past, in order to earn an interest rate on those “reserves”, China has bought US government debt (Treasury bonds) with these Dollars. However, due to changing relations between the US and China – especially the application of tariffs – China has decided to invest more of its reserves in gold than US Treasury bonds. China is doing this for two main reasons. First, to avoid potential sanctions and other financial restrictions that could be imposed by the US. Second, to step away from helping the US fund its deficits and keeping US interest rates low.
2. (US) Government debt levels
Another reason gold is rising is because of investor perceptions that US government debt is on an unsustainable path. While fiscal deficits and government debt aren’t inherently bad, the increase in government deficits and debt, especially at a time of elevated inflation, is raising fears the value of US debt could decrease and problems relating to the US’s ability to service its debt could increase. These fears are contributing to many investors reducing the amount of money that they invest in US government debt (Treasury bonds) and putting it in gold as a store of value instead. Investors are also fearful of debt levels of other countries. However, the biggest concern is the US economy’s debt levels because of the crucial role the US plays in the global financial system. Following years of explosive growth in US government debt after the COVID-19 pandemic, which saw the US debt-to-GDP ratio rise to 120%, the new Trump administration’s fiscal agenda looks likely to add to debt levels. Some forecasts suggest that Trump’s tax cuts and other policy measures could increase the US deficit by as much as $1 trillion per year, and increase the level of US government debt by as much as $US10 trillion over the next 10 years.
(Source: Committee for a Responsible Federal Budget)
3. Weaker US growth and lower interest rates
An emerging, relatively short-term reason why gold is going up is because the markets are expecting a higher chance of a US recession, primarily due to the Trump administration’s trade policies, and (to a lesser extent) the impact of public employment and spending cuts. Trump’s economic agenda has seen consumer confidence weaken and retail spending drop, while businesses are also delaying employment and investment decisions. As a result, the markets are expecting the US Federal Reserve to start cutting interest rates again to support the US economy through this potential weak patch. Heading into the FOMC’s March decision, the interest rate markets are implying the next cut may come in June, with the high probability of a total of three more cuts this year. Lower interest rates generally mean a weaker currency and lower bond yields. Because gold is priced in US Dollars and lower bond yields relatively speaking increase the appeal of a non-yielding asset like gold, this recent dynamic has also helped push gold higher.
(Source: CME Group)
4. Global geopolitical tensions
Wars in the Middle East and Eastern Europe have supported demand for gold in recent years. There are two main channels in which this benefits gold. Firstly, wars raise the risk of financial sanctions on combatants that are opposed to the US and its strategic interests. For example, gold prices rose after Russia’s invasion of Ukraine as tough financial sanctions restricted institutions and wealthy individuals from accessing US Dollar accounts and US Dollar denominated assets. Secondly, higher geopolitical risks lead some investors to worry about greater future conflicts and the possibility that it will lead to volatility in financial markets and stresses on the financial system. As a result, they look to acquire physical gold that they can store in a safe place in order to secure some of their wealth.
(Source: Trading View)
(Past performance is not a reliable indicator of future results)
There are other short-term factors that are or can influence the gold price. A recent scramble to transfer physical gold into the US out of fear of tariffs being applied to gold imports is another factor supporting gold’s recent rise. Seasonal factors and consumer preferences can sometimes also lift the price. For example, through the demand for jewellery. Supply shocks in parts of the world with a lot of gold mining can also have an impact on prices. However, these are generally short-term in nature. The four factors detailed above are generally considered the main, long-term tail winds for gold.
Can gold prices keep going higher?
The short answer is, yes, it could. Historically, gold prices have trended upwards, with some periods of weakness and underperformance. Generally speaking, as the global economy grows, more money and wealth is created, increasing the demand for a relatively finite (or inelastic) commodity like gold. If the trends outlined above continue, which at present looks likely, then gold prices may continue this long-term trend.