What Drives Gold Prices?

There are many factors contributes in Gold price movement. Apart of Demand/Supply fundamental factor, low interest rates in many developed countries (e.g. US, Japan, UK & ECB) which compels investors to own this precious metal which gives better risk – adjusted return, especially when two other important factors which are key to determining the direction of gold prices also favors.

One is Dollar index, which is plunging & the other is crude oil prices which is surging along other commodities.

On-going turmoil & uprising movements in MENA also makes investors jittery so they opt for safe haven. Another factor which pulls the demand is growing wealth in middle class population in many Asian countries especially in India & China.

What drives current Gold prices?

There could be countless factors, but I specially want to talk about two factors which I can quantify relatively easily.

1)      Gold prices have negative correlation with US dollar index (trade weighted dollar). As US Dollar index is declining, therefore gold is going in opposite direction                 

Correlation between Gold & US Dollar Index	-0.44
USD Dollar Index YTD** Performance	-5.30%
Gold YTD** Performance	5.20%
*3 year (2008-2010) correlation
** 1st Jan 2011 - 19 April 2011

Source: World Gold Council & Bloomberg

                                                       

Gold & US Dollar Index:                                                                                                                                                                                                                                                                                                   

                                                           

 2)      Gold prices have positive correlation with crude oil & other commodity Indices. As Crude oil prices along with commodities are increasing (upward pressure on inflation), therefore gold is surging too.

Correlation* between Gold & Brent Crude Oil	0.35
Brent Crude Oil YTD** Performance	28.80%
Gold YTD** Performance	5.20%

*3 year (2008-2010) correlation
** 1st Jan 2011 - 19 April 2011

Source: World Gold Council & Bloomberg

Conclusion:

Following correlation table could help us to understand the gold price movements.

	Correlation* between Gold	YTD** performance
Gold	1.00	5.20%
Dollar Index	-0.44	-5.31%
Brent Crude Oil	0.35	28.81%
DJ UBS Commodity Index	0.40	5.18%
R/J CRB Index	0.38	10.59%
S&P GS Commodity Index	0.35	12.91%
BarCap US Treasury Index	0.06	0.67%
S&P 500	-0.02	4.37%
MSCI World ex - US	0.13	2.49%

*3 year (2008-2010) correlation
** 1st Jan 2011 - 19 April 2011

Source: IHS Global Insight, Barclays Capital, World Gold Council, S&P &Bloomberg

Therefore as long as crude oil price along with other commodities march towards north & US dollar index slide, gold will continue its upward momentum.

There is an interesting point here as the gold/silver ratio has dropped to its lowest level since 1983, currently hovering around 35. It is way below than 12 years average level of 60 & a year ago level of 65.

We could interpret the ratio as lower the ratio; the more expensive silver is compare to gold & vice versa.

Source: Bloomberg