The price of gold, as each price, is determined by the market forces of demand and supply. The demand is the amount of a good demanded for purchase at a given price. Therefore, the demand for gold is the amount of a gold demanded for purchase at a given price. Gold demand is often analyzed on an annual basis and divided into jewelry demand, technology demand, central banks demand or investment demand.
Gold Technology Demand
The technology demand is the demand for gold for industrial or technical applications (in electronics, dentistry and so on). The technology demand is not a gold price driver. This is because, unlike other commodities (including even silver), gold is practically not consumed. Nearly all gold ever mined in history still exists in some form, therefore technology barely affects the price of gold, it can only support the yellow metal in the long-term (see Chart 1, where the industrial demand was falling between 2007 and 2009, and also between 2010 and 2012, while the average annual gold price was rising).
Chart 1: Technology demand (in tons; blue line, right axis) and gold price (yellow line, left axis) from 2002 to 2014.
Moreover, the yellow metal is only a minor input in electronic equipment, and industry firms are not interested in gold speculation, since they are price-takers, not price-setters. Again, it is the gold price that affects the technology demand (however, not immediately), not the other way around.
Gold Jewelry Demand
Jewelry demand is the demand for gold for jewelry production. There are countless articles in the financial press stating that the demand for jewelry, especially from Asia, drives gold prices. However, consumers do not drive prices, because when the prices rise, they buy less, and vice versa. Indeed, the rising prices of gold in the 1970s and 2000s coincided with declining jewelry demand, while the bear market in 1980s and 1990s was accompanied with a steady rise in demand for jewelry (see the chart below).
Chart 2: Jewelry demand (in tons; blue line, right axis) and average annual gold prices (yellow line, left axis) from 1997 to 2014.
Central Banks’ Demand for Gold
Official demand is the demand for gold for the purpose of reserve management by central banks. The demand from central banks does not drive the price of gold. As one can see in the chart below, the gold price was rising after 2001, despite the fact that central banks were heavy sellers of gold from 1989 to 2009. Contrary, the average price of gold fell from $1,411 in 2013 to $1,266 in 2014, although central banks increased their net purchases from 409.3 tons to 477.2 tons.
Chart 3: Central banks’ demand (in tons; blue line, right axis) and average annual gold prices (yellow line, left axis) from 1997 to 2014.
Moreover, central banks possess only around 15-20 percent of total world gold holdings, while their annual purchases equal to the amount traded during a single day at the London market. It seems that central bank demand can put a floor under the price (or strengthen the existing market sentiment) rather than drive it.
Gold Investment Demand
Investment demand is the demand for gold for investment purposes. This demand is made up of direct ownership of bars and coins, or indirect ownership via Exchange-Traded Funds (ETFs) and similar products. Investment demand is the most important category of demand for gold that really drives the price of gold.
However, the investment demand is much higher than reported by the World Gold Council. How else do we explain the trading of few hundred tons of gold every working day at the London gold market alone? Thus, gold should not be analyzed as a commodity, but like a currency. Just like with other currencies, the demand for gold comes from the marginal buyers of gold. For instance, if the demand of gold increases, it means that buyers of gold value gold more highly and thus are willing to pay a higher price. What does influence the demand for gold? The same factors that affect the supply side: the level of confidence in the economy, the U.S. dollar exchange rate, the level of real interest rates and so on. For example, when people lose the confidence in the U.S. economy, they could buy gold more willingly.
Gold Physical Investment Demand
The gold investment demand is made up of direct ownership of gold bullion, i.e., bars and coins, or indirect ownership via Exchange-Traded Funds (ETFs) and similar products. The former component is known as gold physical investment demand. Gold bars and coins are viewed as a store of value asset by many investors. In particular, if somebody does not trust the contemporary monetary system, physical gold seems to be an interesting investing alternative.
Gold ETF Demand
Although physical gold is an ultimate safe haven hedging against the collapse of the financial system, many investors prefer investing in gold ETFs. They invest primarily in hard gold assets, which are held in trust by the fund manager or custodian, and aim to track the price of gold. The main reason behind the gold ETF demand is to have exposure to gold prices but with greater convenience – it is much easier to build and liquidate positions in gold ETF than in case of physical gold. The biggest and probably the best known gold ETF is SPDR Gold Shares.