he US Federal Reserve plans to raise interest rates this year on the back of an improving American economy, and that is taking the shine off gold.
Why? Because gold is a store of wealth for investors, but generates no returns from regular interest payments or dividend income. Investors have been happy to park their money in gold over the past six years while returns from other 'safe haven' assets have remained low and the economic backdrop has remained volatile. But, with borrowing costs set to rise, commodities, such as gold, are losing favour with investors, as higher returns can start to be generated elsewhere.
The UK interest rate is 0.5pc. In the US, the interest rate, set by the Federal Reserve, is 0.25pc. US Federal Reserve chairman Janet Yellen has suggested interest rates should rise by the end of the year, while Mark Carney, the governor of the Bank of England, also signalled that UK interest rates could begin to rise around the beginning of 2016, if not earlier.
The US dollar has been growing stronger, boosted by a resurgent American economy and the prospect for a rate rise in the next few months. The US dollar index, which tracks the price of the US dollar against the world’s currencies, has increased by more than 20pc within the past year.
The value of the US dollar typically follows an inverse relationship with commodities. When the dollar strengthens against other major currencies, the prices of commodities - such as gold - typcially drop. When the dollar weakens, commodities generally move higher.The main reason for this is because most commodities are freely traded in international markets and prices are quoted in US dollars.
Foreign buyers will purchase commodities with dollars, so, when the value of the dollar drops, they will have more buying power, and demand increases. Similarly, when the value of the dollar rises, they have less buying power and commodities become more expensive, muting demand and sending commodity prices lower.
The slowdown in the Chinese economy, the world's largest consumer of commodities, has also caused the gold price to fall steadily since 2011.
China has increased its reserves of gold bullion by 60pc since 2009. However, the People’s Bank of China revealed it has been buying far less gold than expected.
Gold has been steadily falling since a peak of $1,900 an ounce in September 2011. As the sell-off passed the important barrier of $1,100 an ounce for the first time in five years, it triggered stop-loss orders, which traders put in place to limit their losses by automatically selling when the price reaches a predetermined level. That causes the price to drop even more sharply.
The prospects for gold are not good. The Chinese economy shows no signs of returning to rapid growth, and when interest rates do begin to rise, investors will divert more of their savings away from gold and into interest-bearing accounts. Looking out over the long term the gold price could full much lower.