Gold prices are influenced by a mix of supply, demand, and investment activity. That appears to be straightforward enough, yet the way those components interact is sometimes counterintuitive. Many investors, for example, consider gold to be an inflation hedge. That makes sense, because paper money loses value as more is created, but gold's supply is largely fixed. Gold mining, as it happens, does not contribute much to supply from year to year. So, what is the actual movers and shakers in gold prices?
The three most significant variables influencing gold prices are inflation, supply, and central banks.
Image 1. XAUUSD performance for the last five years (source: tradingview.com)
Gold does not correspond well with inflation, according to Claude Erb, an economist at the National Bureau of Economic Research, and Campbell Harvey, a professor at Duke University's Fuqua School of Business.
But we see when there is a higher inflation (like now) the gold prices are elevated too. It could be fear, but in reality, it’s connected with something called “price elasticity”. This effectively implies that when more individuals purchase gold, the price rises in tandem with demand. It also implies that the price of gold has no underlying "fundamentals." If investors begin to flock to gold, the price rises regardless of the state of the economy or monetary policy.
Gold, unlike oil or coffee, is not consumed, and practically all of the gold ever produced is still in existence, with more being mined every day. If this is the case, the price of gold should fall over time as more of it becomes available. However, it doesn’t fall, because a lot of people are treating gold like a store of value.
Also, central banks are big market movers of gold prices. When the economy is good, and FX reserves are large enough, they want to get rid of it, because it’s a dead asset – it doesn’t generate return.
FED interest rate decision
To fight current inflation in the USA, the Federal Reserve hiked short-term interest rates by 0.50% on Wednesday.
Since May 2000, the decision to hike rates by 0.50 percent was the most dramatic rise made in a single meeting. The Fed has only raised interest rates in 0.25 percent increments during the previous two decades, with the latest decision highlighting the seriousness of the current inflation threat.
This move was already expected after last hike, March 16, at which time FED. Funds rate was 0.12%-0.50%. In the last 2 weeks, we could see movements in EUR/USD, where USD got stronger because of the expectations. And that’s the reason why XAU/USD was getting weaker – there were no flock movements, but intrinsic value of gold was lower due to the fact that the dollar got stronger.*
Image 2. XAU/USD performance for the last 2 months (source: tradingview.com)
In the last 2 weeks, gold price fell an inch under 7%, and bounced back 2.2% after interest rate hike, in less than 24h.*
If there won’t be any flock movement, we could probably see price corelation with the EUR/USD movement.[a]
In Thursday, March 17, ECB President Christine Lagarde sad that the ECB will be in no hurry to raise interest rates and any move will be gradual. However, lately we can see some hints that there could be interest rate hike during July, 2022. As the EUR / USD ratio has been adjusting since last year in line with the Fed's rise in interest rates, it is possible that now is the time for a turnaround that could have an impact on gold price movements.[b]
Image 2. EUR/USD performance for the last 5 years (source: tradingview.com)
EUR / USD is on a multi-year support line, and an increase in interest rates could push EUR / USD upwards, and thus the price of gold on the record levels.[c]
[a,b,c] Forward-looking statements are based on assumptions and current expectations, which may be inaccurate, or based on the current economic environment which is subject to change. Such statements are not guaranteeing of future performance. They involve risks and other uncertainties which are difficult to predict. Results could differ materially from those expressed or implied in any forward-looking statements.
*Past performance is no guarantee of future results.
 Infation: https://www.nber.org/system/files/working_papers/w18706/w18706.pdf
 Lagarde: https://www.reuters.com/business/ecb-has-extra-space-before-first-rate-hike-lagarde-says-2022-03-17/
 July 2022: https://www.ft.com/content/a4b63bca-252f-4a77-9415-a898975a0c81