The Driving Factors Affecting The Gold Market That You Need To Know

Includes: GLD
by: Walter Hin


In recent development, a strong yen has resulted in a strong gold price. Since the yen's strength from 119 to 113, the gold price went up by 12%.

A low oil price is bullish for gold because India, a major oil importer, will pay less, therefore, its current account deficit is small.

Falling stock market, expensive home prices and “dodgy” lending schemes in China may force the Chinese to invest more in gold.

However, a strong USD Index is bearish for gold because other “major” economies will continue its “QE” policies, while the U.S. begins a gradual rise in interest rates.


Gold making a 1- year high of $1,238/oz. from its low of $1,050.60/oz. eight weeks ago is reminiscent of the last four of the five years. It would rally leading up to the Chinese New Year and it would fizzle out for the remainder of the year.

But is this year different from previous years?

Before you get excited, the yellow metal has been in a bear market for five years.

No one knows where gold is going in the future. However, we can look at several fundamental driving factors and judge where gold is likely to go.

Explaining each factor should help us reach a conclusion of whether the precious metal is a bullish or bearish bet.

Some of these factors include:

1. India and China.

2. USD strength and weakness.

3. JPY/USD strength and weakness.

4. Changes in India's current account deficits.

5. The major economies' money stock (M2).

6. Changes to per capita income.

After that, I will weigh these factors and assign the probability of the likely direction for the gold price. Hopefully, this will help you reach your conclusion.

What has happened to Gold so far?

Here is a five-year chart of gold, courtesy of

Chart 1

Click to enlarge

From a technical standpoint, gold has several resistance points at $1,308 (Jan 2015), $1,375 (Jul 2014), $1,425 (Aug 2013) and $1,485 (May 2013).

If gold were to pass these resistances, then it could go on to target $1,600/oz. (which is a three-year high).

What do I think of gold?

My opinion on gold is a commodity with historical precedents, meaning certain groups or sections of society would consume it more than others. However, I see it as an investment that is subject to supply and demand.

I will buy into gold if these groups are becoming wealthier.

Fundamental factors of the gold price

Some of these groups come in the form of countries like India and China, which make up more than half of gold demand.

Chart 2

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Gold is popular in Asia due to its culture and traditions.

But one driving factor for the demand of gold is the increase in per capita income.

Chart 3

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Source: and

At the beginning of the 1990s, it would take a Chinese worker one year to buy one ounce of gold. Today, the same worker would work for slightly less than two months to purchase the same ounce.

You may also wonder why demand for gold fell between 1990 and 2004 when income in China was rising faster than the price of gold.

It is because the government banned gold trading and buying for private citizens until 2004. Since then, gold demand went from 200 tonnes to as high as 1,400 tonnes before falling back to 1,000 tonnes.

Meanwhile, gold demand in India is sensitive to the changes in their exchange rate, government policies regarding gold purchases and its affordability.

Chart 4

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Source: and

The "India per capita/gold ratio" (blue line) saw a rise beginning in the 90s, which in turn saw a rise in gold consumption, and an increase in affordability. But the decline in the ratio saw gold demand stagnant.

The constant depreciation of its national currency, the Indian rupee has made gold more expensive.

Chart 5 Click to enlarge

A weaker rupee means that the average worker needs to earn more of it to buy the same amount of USD.

Finally, when the country's current account deficits reached 5% of GDP, its government intervened in restricting gold imports in 2013. But last year, the Indian government lifted its ban on imported gold, as the current account deficit shrunk to 1.5% of GDP.

So, was the improvement of India's current account deficit down to the restriction of gold imports?

Let's see.

In 2015, India expects to import 1,000 tonnes of gold. So, 1 metric tonne = 32,150.7466 troy ounces, and 1,000 tonnes of gold equals 32,150,746 troy ounces. Using the average gold price of $1,160/oz., therefore, the import value of gold equates to $37.3bn.

But, India is the third major importer in the world at 3.8m barrels/day meaning for one year it imports 1.387bn barrels of oil.

The value of its oil imports in 2014 is $177.5bn, or 38% of total imports; this is equivalent to $128 of oil per barrel.

Assuming that 2015's average oil price is $60 per barrel, along with a similar level of demand, India's oil bill would decline by $94.5bn (a decrease of 47% from last year), that is nearly 'three times' the value of all imported gold!

NB. The Indian rupee has depreciated by 5% from 61 in 2014 to 64.2 in 2015 against the USD.

Will India and China drive the demand for gold in the future?

According to PWC, the economies of both these countries will continue to grow and likely become the number one and two economies in the world in forty years' time.

But, more importantly, is the fact that the global economy will get bigger, and this is supportive of the gold price as the costs of living increase.

You need to consider these driving factors when it comes to gold demand in both countries:

A. Look for the current account deficit in India breaching 5% of GDP.

B. The depreciation of the Indian rupee against the USD makes gold imports more expensive.

C. Look for the depreciation of the Chinese RMB against the USD, if decline accelerates, its private citizens may dump RMB for gold.

D. The ordinary Chinese citizen may lose confidence in the government with falling home prices, stock market and "dodgy" high-interest crowd funded schemes. All these factors are supportive of gold.

E. However, you shouldn't underestimate the Communist party's ability to ban the ownership of gold, if the economic situation worsens in the country.

Market drivers of the gold price

1. Japanese yen against USD

One recent driver of gold moving higher or lower is the strength and weakness of the Japanese yen.

Chart 6

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Source: and

As you can see, yen strength equals stronger gold price (see Chart 6). From 1999, the Japanese yen strengthened from 120 per USD to 80 per USD, this 33% appreciation played a small part in gold's gigantic rise of 800%!

But Japan started its "QE" in 2011 by expanding commercial banks' current account balance from 40 trillion yen to 50 trillion yen, with the latter being achieved by the end of 2012 (that $124bn is smaller than America's QE program, therefore the yen remains strong).

By 2013, the Japanese government took bold steps to print 7 trillion yen or $73bn per month. This move helps to weaken the yen from 80 to 120 against the USD because its "QE" is larger than the U.S., in proportion to the Japanese economy. Meanwhile, gold took a plunge from $1,800 per oz. to a low of $1,060 per oz.

In recent weeks, the rally in gold saw the yen strengthen against the USD (See Chart 7). Apparently, the correlation still exists.

Chart 7

Click to enlarge

What does it mean?

Well, if you believe the Japanese government will continue to weaken its currency, then this strategy is negative on the gold price.

Recent economic data from Japan like collapsing exports, negative GDP numbers and decreasing retail sales numbers point to further "QE", despite its ineffectiveness.

Without further "QE", Japan would lose its exports competitiveness, therefore, exacerbating its trade deficits. Remember, Japan's net international investment position is $3.2 trillion, and if it runs consistent levels of trade deficits, this would reduce its abilities to fund government budget deficits.

2. USD Index

If you are a gold follower, the chart below is no stranger as it shows USD strength = weaker gold price and vice-versa.

Click to enlarge


The direction of the USD plays a huge role of whether gold prices would continue to appreciate.

If the Fed wishes to change course from raising interest rates to cutting interest rates to QE 4, this will take time, plus the Fed would lose some credibility.

3. Money Supply + U.S. nominal GDP

The changes in any economies' money stock are important because it tells you if the economy has too much money circulating in the system (causing inflation) or too little (causing deflation) relative to price rises and the population increases.

Below is the U.S. money stock/gold ratio.

Chart 8

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And it shows that gold is expensive when the multiple is low and cheap when the multiple is high.

For a more accurate measure, we need to account for inflation in gold.

Chart 9

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Although the inflation-adjusted money supply ratio is moving near the high of 1999-2001 (the last time gold was very cheap).

If we compare the gold price and America's money stock (M2), in absolute terms, a pattern emerges which shows a period of undervaluation and overvaluation of the gold price (See Chart 10).

Chart 10

Click to enlarge

Source: and

Currently, the gold price looks to be undervalued relative to the size of U.S. Money Stock.

But, one should also consider the "velocity of money" (how often money changes hands per annum). Therefore, a massive increase in money supply won't cause inflation if the banks won't lend and people don't spend.

In the U.S., the money velocity has been declining.

Click to enlarge


So, for a more accurate measure, you should take money supply M2, and multiply by its velocity (equal to nominal GDP). So how does gold perform against the Nominal GDP of the United States?

Chart 11

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In nominal terms, gold is relatively expensive against the U.S. economy, though it recently got cheaper.

If we "inflation-adjust" the gold price against the U.S. economy, the graph is more compact with gold becoming relatively less expensive, though it is far from the levels of 1999-2001.

Chart 12

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According to the money supply chart of the United States, gold won't return to the levels of $200-$350 because the money supply has expanded considerably in the past seventeen years.


The table below shows if gold were to return to the dark days of 1999-2001, the price would be:


When gold at its cheapest?

How low will the gold price go?

1. M2/Gold ratio (see Chart 8)

The ratio is 19.1

$628/oz. ($12 trillion ÷ 19.1)

2. M2/Gold ratio (inflation) (See Chart 9)

The ratio is at 14.29.

$865.6/oz. ($12 trillion ÷ 14.29)

3. U.S. nominal GDP/Gold ratio (See Chart 11)

The ratio is 39.

$460/oz. ($17.9 trillion ÷ 39)

4. U.S. nominal GDP/gold ratio (inflation) (See chart 12)

The ratio is 29

$618.3/oz. ($17.9 trillion ÷ 29)

Click to enlarge

Unless the economy or U.S. money supply contracts seriously, then the lowest price gold can go are calculated in the table. However, the more accurate measure would be the inflation-adjusted ratios of gold going as low as $618.3, regarding U.S. nominal GDP or $865.6, regarding M2.

Remember the inflation-adjusted ratios work if the world economy is inflationary, in particularly in countries like India and China, the biggest consumer of gold.

Where should the value of gold be?

Gold, like everything else, is subject to supply and demand, but where is the price relative to other asset classes?

For measures like wages and the stock market, it is prudent for me to use the economic data from the United States because it's the only major country to operate under the capitalist system for an extended period.

Plus, using China and India as an economic measure is not realistic because both these countries were operating under a different economic system.

The website measures the purchasing power and relative values of all sorts of asset classes and yardsticks.

I will measure the change in the value of gold versus other asset classes since 1850, unless otherwise stated.

1. U.S. Consumer Price Index (CPI)

This widely used index measures the costs of goods and services. If things cost $1,000 back in 1850, then today the "same things" (we know things weren't same 165 years ago, but speaking hypothetically) would set us back $31,519 today.

Gold was priced in New York at $20.67/oz. in 1850. Investing a $1,000 worth gold then would value today's gold at $58,394.

So, under the CPI, gold has covered the rise in the costs of living.

2. Wages

Using an index, the costs of unskilled labor is 82.5 in 1850. Today, it has jumped to 18,582.84, an increase of 224.2 times! Meanwhile, the gold price increased by 57.34 times since 1850, so for gold to cover the increase in wages of unskilled labor it needs to be trading around $4,634/oz.

What about a production worker?

Hourly compensation for a skilled worker is $0.06 back in 1850, whereas today (2014) it would cost the employer $29.40/hour, a rise of 489 times, the equivalent of gold rising to $10,108/oz.

3. S&P 500

The S&P 500 was created back in 1871 and trading at 4.44. Meanwhile, gold was at $23.09/oz.

Today, a $1,000 investment in the S&P 500 in 1871 would have earned you a capital gain of $432,108 or a rise of 43,210%. So, gold needs to rise to $9,977/oz. to match the S&P 500 performance.

4. Oil price

According to the, WTI Crude was priced at $0.49/barrel back in 1861 meaning the most used natural resource in the world has risen by 62.3 times, compared with 57.34 times for gold.

And, despite oil falling by 70%, gold priced in oil terms would fetch $1,287/oz.

5. Platinum

A metal that is rarer than gold but currently priced below it. The mining of platinum per year comes to 133 tons compared to 1,782 tons of gold.

Back in 1966, gold was priced at $35 per ounce, whereas platinum was going for $83.21 per ounce.

Since then platinum has reached $943 per ounce vs. gold of $1,232 per ounce. Therefore, in Platinum terms, gold would be valued at $361.6 per ounce.

Either this proves scarcity does not equal higher value or platinum is very undervalued versus gold!

So, gold has underperformed against various asset classes, apart from CPI, but does that seriously undervalue gold, or is the "yellow metal" a better measure of inflation, or subject to the demand of China + India and the world central banks?

Here are some interpretations for you from the above results:

1. The CPI is not the best tool to measure inflation because the basket of goods and services lag behind consumer tastes.

2. The gross wages of laborers do not account for savings (which is deflationary), and why it depresses the gold price.

3. Measuring the performance of the gold price against 500 largest businesses (at the time) in the country is misleading. The reason is there are a lot of business failures. For a firm to fit into the S&P 500 it must have a proven and growing business model.

According to the Small Business Association, it states that half of all small businesses will survive after five years, and one-third would survive after ten years.

NB. Business failure dents the performance of any index and is deflationary.

If America were to create an index that accounts for every business operating in the country, I would bet that index will underperform the S&P 500 almost all the time.

4. Measuring gold against oil seems realistic because oil is always in demand around the world and the oil price gauges the mood of the global economy.

Where will gold go from here? - The big takeaway

In the long term, the gold price will rise in absolute terms if the global economy grows and inflation persists.

To know where gold will move in the short term and medium term is a more difficult task to assess because the world economy has so many moving parts.

The best to do is to weigh the probability of certain events happening.

A. Gold demand will continue in India without import restriction, this I give a 70-80% chance because oil prices are low due to oversupply. - Bullish for gold

B. U.S. Index to go higher? Given that the Fed had raised interest rate last year, the "U-Turn" back to further QE will take longer. Given that the major economies in the world are facing worsening economic prospects than the U.S. and troubles lurking in the emerging economies, the USD would maintain this level or go higher due to flight to safety. Therefore, I give an 80% probability for the USD Index to maintain or strengthen against the euro, yen, yuan and GBP, as well as the Indian rupee. - Bearish for gold

C. Is the Japanese yen going to weaken or strengthen? With no further QE announcement from Kuroda (Japan Central banker), this has sent the yen stronger.

But negative Japanese economic indicators will probably force Kuroda's hand to reinvigorate the "printing press", this is a 90% probability because a stronger yen equals weaker corporate profits/loss. Given that most Asian currencies have weakened, a strong yen, this time, around would lead to a bigger loss for its conglomerates. - Bearish for gold.

D. Are Chinese citizens turning their attention to gold?

Housing in China is expensive (Chinese housing inventory range from 441m Sq. m to 3.6bn Sq. m, depending on the source), the collapse of its stock market last year, and scams like "peer to peer lending", these are the few reasons for the Chinese to invest in gold.

But more importantly, is the possibility of the depreciation of the yuan. So, the probability of Chinese people demanding increasing amounts of gold is 90%. But don't discount the government on imposing a restriction of gold purchases in the future. - Bullish for gold.

So, weighing up the pros and cons for gold, I can conclude that I am 50% bullish on gold in the short and medium term and 95% bullish on gold over the long term.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.