Gold Signals – A Beginner’s Guide, Part 1

Last Update: June 15th, 2020

FX Leaders is constantly evolving and expanding its services, we recently incorporated another exciting financial instrument into our forex trading signals program – gold trading signals!

How to Trade Gold?

Gold can be electronically traded in the same way as currency pairs. Retail forex brokers usually facilitate gold forex trading by means of a contract for difference (CFD). This enables retail forex traders to easily participate in the gold forex market where they can engage in both long and short positions on this precious commodity.

Because gold can be readily traded on retail forex trading platforms and because it is traded in basically the same way as currency pairs, many people search the internet for terms like ‘gold forex’, ‘forex gold’, ‘gold fx’, and ‘fx gold’, to learn more about this incredible financial instrument, and how to trade it successfully.

This coveted and prized metal has played a major role in how humans are distributed on planet earth. Over the centuries and millennia of human existence, countless miners and prospectors have traveled thousands of miles in search of rich deposits of this highly valuable element.

A statue of a Yukon prospector

In these modern times, gold is still a very important commodity. It is also a great financial instrument that is traded in large volumes, both electronically and physically.

Let’s take a closer look at gold’s history, production statistics, and most importantly, how to trade gold.

History

For thousands of years, gold has played an integral role in mankind’s social, political, and financial activities. Ancient kings used to amass large quantities of gold with which they hired armies, decorated buildings, and made fancy crockery and other royal artifacts. Gold has also been used in dentistry for nearly 3000 years and is a biocompatible metal which is safe to use in direct contact with a person’s body.

Although gold has been used as a payment medium for thousands of years, the first gold coins that were used were struck by Lydian merchants in about 700 B.C.

Nowadays, gold has many more uses than back in ancient times. It’s a superb conductor of electricity and is used in many electronic devices, including computers and cell phones. It doesn’t tarnish and is highly malleable and flexible.

Of course, gold is still used to make jewelry, certain coins, and a wide variety of artifacts.

The Gold Standard

The gold standard is a monetary system where gold is linked directly to a country’s currency. With the gold standard, countries bound themselves to convert paper money into a fixed amount of gold. Of course, this necessitated them to set a fixed price for gold trading at which it could be bought and sold.

The Bretton Woods Agreement was a system of monetary management which governed financial and commercial relations with the United States, Australia, Japan, Canada, and Western Europe between 1944 and 1971. This system obligated the participating countries’ central banks to maintain fixed exchange rates between their currencies and the U.S. dollar. In those days the dollar was linked to gold, which was fixed at $35 an ounce for most of the duration of the Bretton Woods era.

Unlike the classic gold standard of the 1800’s, the Bretton Woods Agreement used a pseudo gold standard. Private individuals couldn’t convert their dollars into gold; only central bankers could. Neither could other countries convert their currencies directly into gold. Only the dollar could be redeemed for gold.

The Bretton Woods agreement stated that foreign central banks could go to the Federal Reserve in New York and exchange their dollars for gold, or their gold for dollars at $35 plus 8.75 cents commission. In those days it was illegal for U.S. citizens to own or trade gold, except for collector’s coins and some jewelry. This law was implemented in 1933, and only in 1975 could Americans freely own and trade gold again.

At the advent of the Bretton Woods system in 1944, the gold price was US$35 in the United States. This price was set back in 1934 and remained fixed throughout the Bretton Woods era.

Although the Bretton Woods system was a remarkable cooperation between the different countries involved, several factors worked against it in the end, of which gold price arbitrage was one.

Effects of the Bretton Woods Agreement

In September 1960, the gold in the London gold market began trading higher than the ‘arbitrage’ price of $35.17 when it traded at $35.20. The cost of buying gold in New York was $35.0875 including commission, plus 8 cents shipment to London equals $35.1675. Let’s round it to $35.17.

Anything higher than this would incentivise buying gold in New York and shipping it to London to earn the arbitrage profits. About a month later, on October 20, the gold trading price bounced to $36 which was now well above the arbitrage ceiling of $35.17. A week later speculators pushed up the price to between $38 and $41 an ounce which now offered a handsome premium to import gold from New York to London.

In the meantime, the U.S. had been printing more and more dollars and the pace at which capital flowed out of the U.S. only accelerated. Foreign central banks accumulated more and more dollars and were redeeming more and more gold from New York, which started to put pressure on American gold reserves.

Gold bar production in the United States

To counter the problem of rising gold trading price in London, the Federal Reserve cut an informal deal with the Bank of England to resupply the bank with any gold it spent in an effort to suppress the gold price. This was done at the Bank of England’s discretion. The combination of this tactic with other U.S. regulations managed to cap the gold trading price, and by March 1961 the price had been artificially pushed down to $35.10.

The last major effort to keep down the gold trading price was in 1961 when Western central banks stood together and pooled several hundred million dollars worth of gold which would be mobilized to try and cap the London gold price. This was called the London gold pool. This great stockpile of gold contained the price of this precious metal for some time, but in the end, there was no way that these central banks could continually satisfy the ever-increasing demand for the gold.

America kept on printing money to finance its military spending which increased substantially with the acceleration of the Vietnam War in 1965. At this time, President Lyndon Johnson’s Great Society Project, which was very expensive, also required money. This project was partly funded by the Federal Reserve which issued new money to buy government debt.

Supply and Demand in the Gold Market

With the substantial increase in the supply of dollars, which led to more and more gold redemptions by foreign governments, America’s gold reserves were being depleted at an alarming pace. Foreign speculators were aware of this and knew that the U.S. wouldn’t be able to withstand the continual depletion of its gold reserves. Hence, these speculators went on trading gold and bought gold at a record pace, which became a major problem for the famous London gold pool.

By March 14th, 1968, the gold pool members had sold $2.75 billion of this yellow metal which depleted about 10% of their reserves. Gold traded at $35.20, which was their line in the sand. Enough was enough. The members asked the Queen of England to close the market the next day, and the pool was dissolved. Two weeks later the market was opened again. Now the gold price felt a little resistance and immediately shot up to $38 an ounce. Soon after this, the price rose to $42 an ounce.

Needless to say, the U.S. was eventually forced to disconnect the dollar’s value from gold completely (by President Nixon in 1973), and the price of gold quickly rose to $120 per ounce. The Bretton Woods system became history.

Since then, the gold trading price has been much more dynamic and its value increased until it topped out in 2011, when it briefly broke through $1900 per ounce. After this important top was set, the price moved sideways for about a year, and then entered a bear market, which lasted for several years. An important bottom was set in 2015 at about $1044. From there, the price has recovered somewhat but still, lacks serious bullish momentum.

Largest Producers of Gold in 2019 (Mine Production)

1. China – 399,700 kilograms

At the moment China is the world’s largest producer of gold. It has also been the world’s largest consumer of gold for ten consecutive years.

2. Australia – 312,200 kilograms

Australia is incredibly rich in mineral resources such as zircon, bauxite, ilmenite, rutile, and iron ore, of which it is the leading producer globally.

Although it takes second place when it comes to gold production, it’s mine reserves far outweigh that of China.

3. Russia – 281,500 kilograms

Russia is an extremely gold-rich country which is not surprising if you consider that it’s the largest country in the world with an enormous land surface of 17,075,200 square kilometers.

Although Russia has extensive natural gold reserves, only 250,000 kilograms of it was mined in 2016.

4. United States – 253,200 kilograms

Although the United States only comes in at fourth place with its gold production, it actually has the most stored gold in the world. More than 8000 tons are held by the Federal Reserve in vaults under New York, in Fort Knox, and elsewhere.

The United States Bullion Depository, also known as Fort Knox. It is situated in the U.S. Army post of Fort Knox, in Kentucky.

5. Canada – 193,000 kilograms

Just to add a personal story for a moment; I had a really great experience in Canada when I was 17 years old. I was selected for the South African national road cycling team which participated in a 7-day world cup race in Val-d’Or which is in Quebec. It is called the Tour de le Abitibi.

To make a long story short, one of the stages, the individual time trial, was held in the last place you’d expect a bicycle race to be held – a gold mine. “Since 2000, one stage of the Tour de le Abitibi takes place in the underground mine, some 300 feet (91 m) below ground. Cyclists must ride through the tunnels and up the access ramp (a 17% slope) before racing through the streets of Val-d’Or”. This mine is called the Lamaque gold mine.

This was really interesting because we went down into the mine like a typical miner would have – hard hats on, mining lamps on our hips, and into the cage-like lift which took us down to the starting point. It was almost like a bicycle race and a gold mine tour in one.

I can still remember how steep and slippery the access ramp was. As soon as you got out of your seat to put more power onto the pedals, your rear tire started to slip on the wet road surface. Then, when you reached the top, you struck a sizzling 40 degrees Celsius as you exited the mine, which is only about 12 degrees at the bottom where we started the race. What an experience!

6. Indonesia – 190,000 kilograms

Indonesia replaced Peru as the sixth largest producer of fold after witnessing a 23% increase in production during 2018. A single open pit operation located in Grasberg accounts for 40% of the island nation’s gold production.

7. Peru – 155,400 kilograms

Peru experienced a slight increase in gold production in 2019, from 151,000 kilograms in 2017. 2014 was a pretty slow year for Peru in terms of gold production levels and exports, but since then things have been looking better for the Peruvians.

Although Peru’s gold production increasing, illegal gold mining activity remains a problem.

8. South Africa – 123,500 kilograms

Much of the development of this country can be attributed to the abundance of its natural resources, but especially to its bountiful gold reserves.

Although South Africa is a really large country, Russia’s land area is more than 14 times as large. However, when you compare the two countries’ natural gold resources, South Africa’s gold concentration is much higher than Russia’s. Russia has an estimated 8000,000 kilograms of unmined gold, whereas South Africa has about 6000,000 kilograms. That means Russia only has 33.33 percent more natural gold than South Africa, but it is more than 14 times as large.

If you calculate the gold weight to land area ratio of Russia, it comes to 468 grams of gold per square kilometer. In South Africa, it is 4.91 kilograms of gold per square kilometer – more than ten times the concentration.

My grandmother’s father, Hannes de Lange, had a gold mine in Rhodesia, which is now known as Zimbabwe. When gold was discovered in Pilgrims Rest which is in the former Eastern Transvaal (South Africa), he moved there but he had less success than in Rhodesia, unfortunately.

In those days (around 1873), there was a huge gold rush, and miners found substantial amounts of gold dust in the streams of the Pilgrims Rest area. Nuggets were also found, and the largest recorded one weighed 214 ounces (more than 6 kilograms). What a find!

Something interesting about South Africa is that it was the world’s largest producer of gold until 2006. Since 1980, however, its gold production has fallen an incredible 85 percent. Some of the factors which contributed to this massive decline were the rise in labor costs and, of course, all the stoppages caused by striking laborers demanding higher salaries and better benefits.

9. Mexico – 121,600 kilograms

Mexico’s gold production decreased in 2018 and 2019 from the 130,500 kilograms produced in 2017. Nevertheless, there have been numerous new discoveries and new mining developments in the region as of late.

10. Uzbekistan – 101,800 kilograms

Uzbekistan’s gold production stayed constant from 2017 to 2018 and into 2019. There hasn’t been much investment in prospecting lately, and the country has been mining from old mines for quite a while.

Countries Boasting the Largest Mine Reserves of Gold in 2019

The Fimiston Open Pit, also known as the Super Pit (Kalgoorlie, Western Australia), was Australia’s largest opencast gold mine until 2016. Since then, the Newmont Boddington mine, which is also in Western Australia, has been the largest.

1. Australia – 10,000,000 kilograms

That’s a lot of gold! Of course, if we take into account the size of this continent, this extremely large number makes more sense. As mentioned earlier, Australia’s gold production in 2016 was 270,000 kilograms, which is 2.842% of its natural reserves. If the country continued to mine gold at this rate (which isn’t quite possible for practical reasons), it would be able to keep producing gold for the next 35 odd years.

2. Russia – 5,300,000 kilograms

As mentioned earlier, this country is extremely large. In fact, it is the largest in the world. This makes Russia’s massive gold reserve somewhat less impressive. Nevertheless, it is a great asset to the country, and at the current mining rate of 250,000 kilograms per year, this reserve should last another 32 years.

3. South Africa – 3,200,000 kilograms

Now, this is more impressive! Although South Africa is a very large country, it only ranks 25th largest in the world. Therefore, a 6 million kilogram gold reserve is really something to boast about! At the current pace of gold mining in South Africa, its gold reserves would only be depleted in about 43 years.

Although South Africa has three times more natural gold than China, the latter mines more than three times as much gold as South Africa. Surely, there are many different reasons for this, but the labor problem in South Africa is definitely one of them.

As mentioned earlier, there have been frequent disruptions in gold production over the last couple of years. Strikes by miners have caused major losses to both the mining industry and the country’s economy. And when the South African locals strike, it is normally not without violence and a breakdown of different kinds of infrastructure, and other valuable things like vehicles, etc.

Contrary to this, Chinese laborers are generally disciplined, hard-working people, which is excellent for any industry’s productivity.

Labor in China is also substantially cheaper than in South Africa.

4. United States – 3,000,000 kilograms

The United States of America is the third largest country in the world. With 3000,000 kilograms of unmined gold, it could maintain its current mining pace of 209,000 kilograms for the next 14.35 years.

5. Indonesia – 2,600,000 kilograms

Although much smaller than the United States, Indonesia contains the same amount of natural gold resources. At the current production rate of about 100,000 kilograms, this country would only deplete this resource in about 30 years’ time.

6. Brazil – 2,400,000 kilograms

Brazil is the fifth largest country in the world. Its gold reserves could last about 48 years at an annual mining rate of about 50,000 kilograms.

7. Peru – 2,100,000 kilograms

Peru is much smaller than Brazil and Canada, yet it contains the same amount of natural gold reserves. At the current rate of mining, its reserves could last about 16 years.

9. China – 2,000,000 kilograms

Although China has a relatively small amount of natural gold reserves, it is currently mining more gold than any other country in the world. If the Chinese were to continue mining gold at this incredible pace, its resources would be exhausted in less than 5 years!

9. Canada – 2,100,000 kilograms

Canada is about 17% larger than Brazil but contains roughly the same amount of natural gold. However, much more gold is mined in Canada at the moment. The current mining pace (170 kilograms per year) would deplete its natural reserves in about 14 years.

10. Uzbekistan – 1,800,000 kilograms

Uzbekistan is the 56th largest country in the world, which makes this number quite impressive. After all, it is more than 22 times smaller than Canada, but contains only about 30% less gold than Canada. The current mining rate would deplete Uzbekistan’s gold reserves in about 17 years.

Gold and Forex

Due to the fact that gold is mostly priced in U.S. dollars, it is, to a great extent, inversely correlated to the dollar. When there is a broad weakening of the dollar against other currencies, these currencies automatically have more gold purchasing power (directly due to the fact that gold is priced in dollars).

The effect is that the demand for gold increases, which in turn raises the gold price up to the point where it reaches a temporary state of equilibrium, so to speak.

The Hound and the Hare

Of course, this inverse correlation between the U.S. dollar and gold isn’t perfect. It is often a bumpy ride. You know, when a greyhound chases a hare in the field, you often see how the hound overshoots the sharp turns made by the hare as it attempts to sidestep its foe. Some say this is because the hound is merely running for a meal while the hare is running for its life. I suppose there is much truth to this idea, but the main difference in their agility and performance is obviously because of the difference in their body structures.

The hare is like a formula one car – flat on the ground and fast around the bends, while the hound is like a Ferrari fitted with a dragster engine. Both are fast but, one is faster, while the other one has more control.

It’s the same with gold and the U.S. dollar. They are two completely different instruments which are largely connected to one another, but many times their inverse correlation is totally thrown off course.

When we compare different financial instruments, we should be aware that their correlations don’t last forever. The hound overshoots many times, and sometimes the hare gets away completely. One thing we should never forget is that markets are imperfect.

With all that said, there have been times when the gold price and the dollar have moved in tandem.

Besides the U.S. dollar’s inverse correlation to gold, there are several other instruments which are either negatively, or positively correlated to it. The Australian dollar is an example of a currency which is often positively correlated to gold. This comes as no surprise if we consider how important this commodity is to Australia.

The Australian dollar is correlated to the gold price

The Japanese yen often displays a positive correlation to gold. Since the dollar is negatively correlated to gold, the USD/JPY is subsequently inversely correlated to gold as well.

Although it’s not a currency, silver also moves with gold many times. However, much of this has to do with the dollar, because silver is also priced in dollars. Of course, there are other factors which also play a role in this correlation, but we’ll have a look at those at a later stage.

Gold as a Safe Haven Asset

Let me ask you something – if you knew that your country’s currency would be worthless in a few months’ time, what would you do with your money? What would you buy if you didn’t have access to offshore investments, online trading, or physical foreign currency?

Does it sound a bit far-fetched? Well, it has recently happened in Zimbabwe. After hyperinflation reduced the value of the Zimbabwean dollar to basically zero, it was demonetized in 2015. People who held onto their Zim dollars until the very end got one U.S. dollar for every 35 Quadrillion Zim dollars they had in their bank accounts. What a joke!

So, what would have been a really effective hedge in this case? Or, alternatively, a safe haven asset to exchange your money for? Remember, we’re looking for something other than foreign currency banknotes (in many countries it is illegal to possess foreign currencies).

Gold could have been a powerful hedge against such a mighty currency devaluation. Of course, there are other commodities and goods which also offer financial safety, but few can be converted into cash as easily as gold, and few are compact enough to transport as easily as gold.

Now you might say, what would cash help me if it lost all of its value? Well, that’s what’s so good about gold, it can be converted into almost any currency with ease. When the Zim dollar was demonetized, Zimbabwe moved over to the U.S. dollar, which is the world’s number one reserve currency.

Other currencies like the Euro, Pound, Japanese yen, Indian rupee, South African Rand, etc. were also accepted. This means that if you possessed gold instead of Zim dollars, you would have had an asset which you could have exchanged for any of the above-mentioned currencies with ease. All of your hard-earned money would be safe because you moved it into a safe haven asset.

How is Gold Used as a Safe Haven Asset?

This is a very basic example of how gold can be used as a safe haven asset. In the investment world, gold is a very important financial instrument used by investors to diversify their portfolios. In a free market system, gold acts like a currency and is a currency. It is a highly liquid asset which often performs well when confidence in paper money wanes.

When stock markets plunge, or when war threatens, gold tends to attract buyers who are in urgent need of financial safety. The risk of gold becoming worthless, or almost worthless, is minute. However, fiat currencies and certain other assets, which are exposed to credit risk (and other risks), are particularly vulnerable in times of political or financial instability.

Gold is a popular safe haven asset when war is on the horizon.

Although the gold standard was abolished many years ago, investor psychology tends to lean towards trading gold when the U.S. dollar weakens. Of course, when the dollar moves lower, gold normally becomes more valuable to investors around the world because gold is mostly priced in dollars.

Nevertheless, besides the natural effect of this inverse correlation to the dollar, gold can be a powerful safe haven as an alternative to the dollar. It also has great potential to protect investors from broader systemic risks in the financial world. It can act as an insurance against the modern monetary system which is largely based on the U.S. dollar, a fiat currency.

While we’re discussing gold as a safe haven, I think it’s important to note that the extent to which gold acts as a safe haven asset will not necessarily remain constant in the future. Let’s say a lot of funds flow into gold trading over the course of a few months or years because it appeals to investors. If market turmoil suddenly broke out and fear gripped the investment world, some of these funds would possibly need to be moved to other assets or portfolio holdings because of liquidity constraints, for example. In this case, gold could be a weaker safe haven asset than expected.

Other factors which need to be brought into consideration, are that other safe havens might actually be more desirable than gold in times of instability and that the unwinding of carry trades could be an important determining factor of where money flows when fear grips the markets.

Another Example

The Japanese yen is a very important safe haven asset. Investors often borrow Japanese yen (at close to zero percent interest) and use it to buy riskier assets with a higher yield, like stocks, high interest bearing currencies like the New Zealand dollar, the South African Rand, etc.

When fear takes hold of investors and they scramble for safety, these assets are exchanged for Japanese yen again, which can strengthen this currency considerably. The funds return to where they originated from, and this flow lifts the funding currency (the yen). Japan’s political and economic stability also makes the Japanese yen a safe haven.

In the second part of this article, we’ll cover all the important aspects of how to trade gold. This will include information about the pip value, contract size, profit and loss calculation, correlated instruments, and the major economic events that can impact the gold price.

Click here to read the second part of our Gold Trading Signals Guide.

Happy Prospecting!