What Is Driving the Price of Gold?

This is a reprint without changes or updates from a posting on this site on 18 January 2008.

Someone had asked about it, and so I looked and found it.  I stopped updating the spreadsheet described in this posting at least three years ago and have not run any correlation analysis since.

I was not using the native regression in Excel, but a bolt-on tool that was Excel friend and fairly nice, if a bit pricey.

As I have stated in the past, I suspect that the greatest correlation now is to manipulation of price, especially since about 2013.  Trading in precious metals has become very political since they almost let it slip lose in 2012.

I use the term 'we' quite a bit.  I had some help behind the scenes at that time.  It seems odd now.  The time period covered in this analysis is roughly 2003 to 2008.  I had done and published quite a  bit of this sort of thing on my old blog Jesse's Crossroads Cafe.  I used to trade futures actively and would put up ten minute charts of the SP futures three or four times a day.

As I have mentioned several times I think the Dollar DX index is passe,  All you have to do is look at its weighting to see it is a child of Bretton Woods.

One thing I did not mention here is that the weightings of the variables did differ over periods of time.  They were averaged and not always usefully so.  I did quite a bit of work trying to 'crack' the variables looking at their own subcomponent factors.  This I never did publish anywhere.

 What Is Driving the Price of Gold?

As regular readers know, we keep a number of spreadsheets with economic data on them, to help us in tracking various measures of the markets and the economy. One of the things we like to do is to look for intermarket correlations using some relatively good multivariate regression software.

We last took a look at the price of gold a few years ago, and not surprisingly found a high correlation to M3. Since the Fed no longer supplies this data, we thought it might be interesting to see what a fresh analysis turned up for this leg of the gold bull market.

The spreadsheet we used contains weekly data on 35 categories of economic and market measures since January, 2003 which is 265 observations and more than enough for statistical validity. Most of the data comes from the St. Louis Federal Reserve official database.

We aren't going to go into the methodology we used to find correlations, as it gets a bit technical and very tedious. Let's just say its all about finding the prime candidates, and then trying a significant number of 'better or worse' fits. The measure of 'fit' used is the R-Square Adjusted which is expressed as a percentage. The higher the percentage, the more the model explains the price of gold. And before the quant geeks come out of the woodwork, we stipulate that we have simplified and rounded both the equations and the concepts for more generalized readers.

The US dollar is the most obvious factor to check as a driver for the price of gold (in dollars), but our analysis showed that the dollar only explains about 58% of the price of gold since 2003. Money supply is the next most obvious factor. Since we no longer have M3 available as data, we went a different broad measure of money supply, Money of Zero Maturity, MZM. It is what the Fed refers to as the best measure of liquidity in the system, and is M2 less small-denomination time deposits plus institutional money funds. If it included eurodollars and net repos, it would be roughly equivalent to M3.

As you can see from this equation, the Price of Gold (POG) equals .261 times the Money of Zero Maturity supply NSA (Not Seasonally Adjusted). Since .261 is a positive number, we say the correlation is positive, meaning as MZM goes up, the price of gold will go up. The actual number itself means little since we are comparing the price of gold in dollars versus the MZM in billions. The R-Square Adjusted is about 89% which is a very high correlation for a single variable.

POG = 0.26 * MZM NSA billions - 1281
R-Square Adjusted 89%

The way we would state the above result is that the Price of Gold is positively correlated with MZM (NSA) to about 89% from 2003 to today. While the money supply as measured by the broad liquidity measure MZM is increasing, the price of gold will be increasing over time, with an accuracy of about 89%. You could say that each billion in MZM results in about 26 cents to the price of gold, but that is a little misleading since its happening over such a long period of time.

Now, 89 percent sounds good and it is for one variable. As the usual suspects go, liquidity supply of the US dollar is the prime candidate. But we wanted to add some of the other suspects in combinations, to see if we can improve on that without getting ridiculous. When we worked many years ago at Bell Labs, we sometimes saw techs taking projects like this to an impractical degree of fineness, certainly well beyond anything that might be applied to the practical problem at hand. We used to call it "trying to measure the depth of the ocean with a micrometer."

Without getting into too many details, about 50 software runs later we arrived at the following best fit for the price of gold since 2003.

POG = 0.1607 MZM NSA billions + 34.3 EFF + 12.3 Moody's Baa - 740
R-Square Adjusted 94.6%

EFF is the Effective Fed Funds Rate. This is the market expectation of what the Fed Funds rate as expressed as a volume weighted average of all the actual transactions. Moody's Baa is the interest rate for Baa corporate bonds. Its a measure of perceived riskiness in the corporate environment.

So we would say that the price of gold is positively correlated to the growth in the liquid money supply (MZM) and negatively correlated to the higher short term official interest rates and positively correlated to corporate risk. with about 95% accuracy. Makes sense? Passes the red face test? Pretty much we think.

So, if you think on the whole that MZM will keep increasing and the Fed will be lowering short term rates, with a dash of corporate risk in the mix, the price of gold should continue to do well over the long run. Since these variables also feed into the valuation of the US dollar as expressed as DX, without the noise of currency manipulation, we should see a similar negative correlation to the dollar over time.

Well, you might say, that's all very well and good if you are a long term holder of gold for five or more years AND things remain as they are, but what about the shorter term price of gold?

We've been doing a lot of work in this area, and most of it would become incredibly complicated very quickly if we tried to explain it here. Let's just say that the relationship to money supply and EFF is definitely still there, but with a great deal more noise in the model, even if the statistical sample is no smaller than one year. This is where DX comes back into play as a modifier and adds something to the mix. By introducing a risk variable like VIX we have been able to take the R-Square up to 94%.

The market place of buyers and sellers obviously sets the price of gold. As the saying goes, in the short run it's a voting machine (with appropriate antics) and in the longer term its a fundamental discounting machine; what drives it in the short term is somewhat different from what drives it in the longer term.

One might ask, "why don't you factor in Central Bank gold sales?" Prior to 2003 we think they were a significant factor in the price of gold, and several people did quite a bit of work in this area. Since 2002 the data leads us to believe that central bank gold sales have had an increasingly weak and temporary effect on the direction of the price of gold. Why engage in complexity when the data analysis is so straightforward without it?

In summary, the data indicates that since 2003 the price of gold in US dollars is strongly related to the growth in a broad money supply measure like MZM or M3. What the market thinks the Fed intends to do with short term interest rates and therefore money supply growth, Effective Fed Funds, is also a powerful factor. Finally, the perception of riskiness in the business world has a smaller but significant effect, as we see in using Moody's Baa rates and also the VIX.

We expected DX to play a stronger role in driving this leg of the gold bull market, but apparently it is playing a role only in the short term wiggles. If it is money supply expansion and lower short term interest rates that has been driving the price of gold for the past five years, with a bit of riskiness tossed in for spice, then the outlook for the price of gold over the forseeable future looks bright. In some future pieces we will touch upon deflation and credit crunches, but for now those remain possibilities and not certainties.

So what drives the price of gold? In this case, as in so many other financial questions, it always seems that we must follow the money.

Gold Daily and Silver Weekly Charts - Gresham's Law, Mispricing of Risk, & the Synthetic Gold Carry Trade

"Gold is unique among assets, in that it is not issued by any government or central bank, which means that its value is not influenced by political decisions or the solvency of one institution or another."

Salvatore Rossi, Central Bank of Italy, 30 Sept 2013


Real gold does not fear examination or the furnace.

Chinese Proverb


"Gold has worked down from Alexander's time. When something holds good for two thousand years I do not believe it can be so because of prejudice or mistaken theory."

Bernard M. Baruch


"You have to choose between trusting to the natural stability of gold and the natural stability and intelligence of the members of the government. And with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."

George Bernard Shaw


"Those entrapped by the herd instinct are drowned in the deluges of history. But there are always the few who observe, reason, and take precautions, and thus escape the flood. For these few gold has been the asset of last resort."

Antony C. Sutton


Gresham's law is an economic principle that states:  When a government overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.

And this is why gold is flowing from West to East.

There was a fairly lengthy intraday commentary on gold and silver which you might wish to read here.   It covers quite a few topics related to the precious metals.

Surprisingly enough there was an actual delivery of silver at The Bucket Shop yesterday as Nova Scotia stopped 43 contracts for its 'house account.'

Otherwise it was the same old, same old with price going down or nowhere in the highly leveraged, synthetic markets of New York, and with physical bullion slowly leaking out of the warehouses.

The question is not whether or not the financial markets are going to slide into another crisis.  The only real question is when, since there is little to no interest in reform.

"We hypothesize that, having learned from the misadventures of the 1960s, the policy elites, well-versed in the practice of financial engineering and market manipulation, would have seen no need to dump stocks of government gold reserves onto the market, 1960s style, to keep the price in check.

Instead, synthetic gold, sourced in pyramids of credit extended to bullion bankers by central banks with little or no claim on physical substance, have provided a more efficient, better-camouflaged form of intervention. COMEX synthetic gold and related over-the-counter derivatives are traded in macro strategies implemented by hedge funds, high-frequency trades, and commodity funds in pair trades with interest-rate, currencies, equity futures, or even more exotic offsets. The volumes traded are huge, and bear little resemblance to actual flows of physical metal.

We suspect that shorting gold has come to seem like a riskless proposition as long as there is confidence in the Fed. Synthetic gold is the perfect substance for a carry trade: an easy borrow with very low carrying cost and little upside basis risk. Such a hypothesis, in our opinion, does much to explain the incongruity of a declining gold price while fundamentals for paper currency, and the U.S. dollar in particular, obviously deteriorate; while demand for physical gold has exceeded new mine supply for several years running; and while above-ground 400-ounce .995-gold bars located in London, New York, and other financial capitals (in cohabitation with speculative trading activity in paper markets) have steadily dwindled and disappeared into Asian financial centers reformulated as .9999 kilo bars."

Tocqueville Gold Newsletter 2Q 2015

Have a pleasant evening.

SP 500 and NDX Futures Daily Charts - Another Unicorn Plops Out of Wall Street

“Participants in our US markets deal with a technological arms race, conflicts of interest, fleeting liquidity in times of stress, and an ever increasing amount of trading taking place in a vast network of opaque darkness.

The public markets are considered ‘toxic’ by varied participants. Studies point out that institutional bids and offers result in too much price movement. High frequency market makers lament that the orders sent to the exchange, outside their own, tend to be orders that have been ‘exhausted’ everywhere else.

Is this a desirable outcome of modern market structure? Did the Commission envision this when it crafted Reg NMS?”

Joe Saluzzi

Maybe we should call this period in our nation's history 'The Carney Wars.'

Stocks pretty much floundered around today, with the two or three tech stock heavy Nasdaq showing a little more spine.

But they did manage to squeeze out another lipstick-smeared crackhead valued IPO, so mission accomplished.

Light volumes, narrow advances, uncertain global situation, looming recession in Europe and weak domestic economy?

Let's buy.  Monkey rally, yay!!

Hey, we *might* get a rally into the FOMC meeting in December, or into year end to plump up those Wall Street bonuses.

US financials have been cast adrift from the fundamentals of economic performance for some time now.

Chart-wise if the SP cannot make a higher high here, it will start to be looking for another wash and rinse lower.

Some fellows on financial TV were pointing to the Shadow Fed Fund Rate from the Atlanta Fed below, and making the case that the Fed is already tightening, so the rate increase in December will make no difference.

Well, that is one point of view.   Personally I will be looking at what they are paying the Banks for their essentially free reserves, and what the size of their Balance Sheet is doing more than anything coming out of a highly distorted financial market.

I am sitting on cash, waiting to pull on something.  We do have a potential for stocks to go a LOT higher IF this 'cup and handle' formation works.   And if it fails, we could go down to test support in the channel, or a LOT lower depending on what exogenous events may encourage stocks lower.

But these are just scenarios and possibilities for now.  And I think that covers all the major possibilities.  LOL.  This is what the guys who charge you money do, but with more certitude and a very eraseable set of past predictions.   The hits are carved in marble, and the misses, well they are chalk dust.

Let's see what the market has to say, if anything.

Have a pleasant evening.

NAV Premiums of Certain Precious Metal Trusts and Funds

I found it interesting that in yesterday's Comex delivery report, Nova Scotia took delivery of 43 x 5000 ounces contracts, about 215,000 ounces of silver bullion, for their 'house account,' at the price of 14.08.  I include that particular CME report below.

Apparently the Central Gold Trust has proposed a conversion of the Trust into an ETF, rather than accept the acquisition offer from Sprott. You may read that proposal as a PDF document. 

The Sprott Funds are mildly negative in price to their NAV, which is the 'new normal' in this bear market leg in precious metals.

What is not so normal, at least in my recollection, is the deepening negative cash balance which I have estimated for Sprott Silver at a little over $430,000.   And from the low level of cash in its account it looks like Sprott Gold is going to be following them soon, unless provisions are made to raise cash.

As you may recall, the Sprott underwriter Morgan Stanley gets a 4% cut on new offers of units, which has been the usual way in which Sprott has raised funds.  With the premiums close to negative, they cannot execute such an offering without 'diluting' the value of the fund in that offering, which they have pledged in their prospectus that they will not do.

So it appears that selling bullion is the only way to raise the required funds.  I have this from third parties, but Sprott has never said anything otherwise or objected to this interpretation.

Another interesting factor in the Sprott funds is the redeemability feature.  Although it has not happened with silver, there have been a number of redemptions of gold bullion out of the Sprott gold Trust over the past couple of years.  That is a good thing, that the process works, and that one might obtain their physical gold for private safekeeping.

But one might wonder what would happen if there was a 'run on physical gold' as some conjecture might occur, given the divergence in pricing between paper and physical.    According to an informal source, there is no provision in the funds to block, slow down, or attempt to prevent any redemption of the gold or declare force majeure.

The counterbalance for this is, of course, the market.  In order to redeem bullion, one must buy the units in the market at a certain price.  And if someone started buying up the Trust units in size, the price of those units would probably adjust to an increasing positive premium which would mitigate the attractiveness of a mass redemption.  And in the case of a 'run on bullion' I would imagine that holders of units would refuse to sell.  But nibbling at the bullion, as it is on almost all Western gold funds, has occurred.

I include the 'Total Holdings' of the Funds and ETFs for gold below to show the decline in bullion inventory.   And to pre-emptively respond to the misinformation of the bullion banks' gold trolls, who like to claim that this rise and fall in gold inventory is merely a matter of price, I include the same time periods for silver bullion as well.  Nine out of ten investors might notice that silver has had a steep decline in price from its all time highs as well.

One cannot take a single data point alone, and even a cursory examination of the bullion flows globally shows a massive movement of gold bullion from West to East, with some significant declines in the 'free float' of gold in some traditionally strong Western markets, such as London for example.

And the outflows from the Asian markets into strong hands on the mainland and the Western exports to them have been absolutely astonishing.  That the financial media and analysts ignore this, with some even denying it overtly, is shocking I suppose, unless you have been paying close attention to some of their more egregious service to the speculative financial interests for the last fifteen years.

By way of disclosure I own no shares in any of these Funds and ETFs at this time, and receive no money or gratuities from any of the funds which I discuss.  I have owned all of them from time to time. I have owned most of the mining stocks from time to time, except for the more obscure 'juniors.'  I do not prefer one over the other so much as each has its place and use in a portfolio.

As I have indicated recently I am cash heavy for the moment in my short term trading, waiting for the market to provide some additional information to prompt some action.  This is normal now because I am no longer a very active trader.  That is a younger man's game. I prefer to take more intermediate term positions and in size.

My long term holdings remain as they have been.