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What's Driving Gold Prices Higher?

Gold prices struck a three-month high last week even as physical demand, which is a major driver for gold prices, remained weak. Prices have been boosted partly by concerns over geopolitical tensions in Iraq and Ukraine. Another factor that helped gold prices last week was inflows into the world's largest gold-backed exchange-traded fund. Indeed, the second factor is important, as it highlights robust investor demand even as the Federal Reserve continues to ease its bond purchases.

Gold prices near three-month high
Gold prices hovered around a three-month high last week. On Tuesday, prices touched $1,332.10 an ounce. In early trading on Thursday, spot gold prices were still trading at around $1,323.50 an ounce. The precious metal's performance this year has surprised market participants given that the Federal Reserve has been easing its bond purchases.

Indeed, the Fed has continued to reduce its bond purchases at each of its monetary policy meetings this year. And with the economy continuing to show signs of improvement, it is likely that the central bank will completely exit the bond-purchase program well before year-end. It was the Fed's bond purchases, known as quantitative easing, that had pushed gold prices to record high levels in recent years. However, the Fed last year indicated that it would start easing its bond purchases. Not surprisingly, the market sentiment turned bearish on gold, and the precious metal fell almost 30%.

Gold was expected to remain under pressure this year; however, prices have remained resilient so far. Stronger prices have also helped most gold mining stocks, which are up sharply year to date. Year-to-date, Goldcorp (NYSE: GG  ) shares have gained more than 33%. Shares of Barrick Gold (NYSE: ABX  ) have gained more than 7%, while Newmont Mining (NYSE: NEM  ) shares are up more than 10%.

Indeed, stronger gold prices have improved the outlook for gold miners. Miners have also been helped by the fact that gold prices seem to have found a floor. The main driver for gold prices in the absence of the Fed's quantitative easing has been physical demand. It was robust physical demand in Asia that prevented further losses in gold last year. As I have noted before, physical demand will be the key driver for gold prices going forward. However, last week's gains were not driven by strong physical demand. In fact, physical demand in Asia has been rather weak as prices have climbed.

Gold's ascent last week was helped partly by geopolitical tensions in Iraq and Ukraine, which boosted the precious metal's safe-haven appeal. Prices have also been supported by flows into the SPDR Gold Trust ETF, which is encouraging.

Flows into SPDR Gold Trust supporting prices
The SPDR Gold Trust, which is the world's largest gold-backed ETF, saw a 1.4% rise in its assets to 796.36 metric tons in the first two days of this month. This is the biggest two-day gain since November. The ETF had seen an outflow of 550 tons last year as gold prices tumbled.

Inflows into the SPDR Gold Trust suggest that investors are once again looking at the precious metal. The changing investor sentiment is a positive for gold prices. Along with the geopolitical concerns, it should provide some upside for gold prices. Stronger prices, though, would mean weakened physical demand.

Remain bullish on gold miners
Gold miners have been focused on reducing costs since last year as they look to adjust to the new pricing environment. Indeed, the first-quarter results reported by the likes of Goldcorp and Barrick were encouraging, as both companies saw a drop in their all-in sustaining costs. Both companies expect all-in sustaining costs to remain below $1,000 per ounce for the full year.

The outlook for gold miners has improved as the year has progressed. The latest development has further strengthened the bullish thesis on miners.

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Varun Chandan

I have a Master in Finance degree from IE Business School in Madrid. I use the top-down approach when it comes to investing. I like to analyze macroeconomic factors and how they impact individual companies.

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