Gold has had a nice little run-up lately, which always prompts a trickle of emails asking why.  Here at The Gold Enthusiast, we look at demand for gold, supply of gold, currency exchange rates and “geopolitical factors” as being the main drivers for gold prices.

Today let’s take a quick look at the demand side for gold.  We’ve already reported on India’s drop in demand over the most recent marriage season.  Essentially we attributed that to 3 things: a rapid drop in the value of the rupee made gold more expensive for Indians; an increase in taxes on gold sales raised retail prices even more; and a drop in local incomes due to a minor recession in India meant people had less money to spend.  No advanced degree needed to understand that – it’s a pretty standard formula for a demand drop.

Basic economics says if prices rise then one or more of these things happened.  One, demand has risen – the market wants to buy more of it for whatever reason.  Two, the value of the currency has dropped, which gives inflation. Or three, the supply of “it” has fallen below the level of demand, allowing suppliers to raise prices and still get sales.

Let’s jump right to the bottom lines:

Right now we’re seeing a shift in the world economy away from the US Dollar as the underlying measure of value.  The Fed has inflated the supply of US Dollars (USD) to the point where there are simply too many of them out there.  In the past the USD was The Required Currency for trading oil in the world.  Entire books and PhD theses are written about the importance of energy in civilizations, and right now oil still reigns as The Preferred Energy Source.  So that created a lot of demand for USD, which tends to support its value.  The US-Saudi Arabia oil deal meant for decades that oil had to be bought using US Dollars, which created a demand for US Dollars.  Now that China has created a way for oil countries to trade directly with China without needing US Dollars, we can expect the demand for US Dollars to drop. That will decrease the value of the US Dollar internationally, which should result in a rise in the price of gold in US Dollars.

So we expect that will be a driver of gold prices going forward, but not the biggest immediate change in the picture. It does represent a finger pointing at what your friendly Gold Enthusiast thinks will be a bigger driver – a more general decline in demand for the US Dollar. As countries reduce their USD holdings, they’ll be wanting to trade in other currencies. So they’ll be looking around for currencies that are rising in value – and right now there’s one easy choice.

You see, China is stockpiling gold, probably faster than they admit. This increases the value of Chinese Yuan (CNY), which makes CNY an attractive choice.  And now reports indicate that many central banks, seeing the probable decline in the value of the once almighty USD, are looking to increase their holdings of other non-USD assets.  Typically they’ll do this by buying the new asset with the old one they want to get rid of.  They don’t want to have to keep trading base assets, it’s easier to buy something that will hold its value no matter what happens in the currency markets.  And that’s easy – you can quite simply buy gold on the international markets with USD, and you’re done with your base asset buying.  Forever.

Gold is, after all, the gold standard in holding value.

Your Gold Enthusiast thinks that’s exactly what we’re seeing – and he’s not alone.

To butcher Sherlock Holmes, a change is afoot.

Sincerely,The Gold Enthusiast

DISCLAIMER: The author holds no positions in any mentioned securities.  He is long the gold mining sector with small, non-market-moving positions in NUGT, JNUG, a few junior mining stocks, and some covered calls in NUGT, and may trade any of these in the next 48 hours.

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About the Author: Mike Hammer

For 30-plus years, Mike Hammer has been an ardent follower, and often-times trader, of gold and silver. With his own money, he began trading in ‘86 and has seen the market at its highest highs and lowest lows, which includes the Black Monday Crash in ‘87, the Crash of ‘08, and the Flash Crash of 2010. Throughout all of this, he’s been on the great side of winning, and sometimes, the hard side of losing. For the past eight years, he’s mentored others about the fine art of trading stocks and ETFs at the Adam Mesh Trading Group More...