The opinion that gold had lost its traditional safe haven status was very popular two years ago. This year’s reality has shown that gold performed well in the long run, despite a number of unusual market moves amid the rising inflation in 2022.
The price of gold has risen 21 percent by early September since the beginning of the year, outperforming the US stock market dynamics (the S&P 500 has gained 19 percent over the same period) when approaching the Federal Reserve System’s interest rate cut cycle. The prospect of worsening the rates on income-earning assets such as bonds makes them less attractive, which pushes the gold price up. Gold is also benefiting from the inflation-related monetary growth and the increased geopolitical risks. Central banks, including the Chinese one, have been buying record volumes of gold in 2022-2023, returning to the traditional source of replenishing the reserves amid the de-dollarization aggravated by fears of financial sanctions that can be imposed by Western countries.
Forecasts did not ring the bell
The unforeseen nature of the gold price rally was evidenced by the results of the traditional LBMA Annual Precious Metals Forecast Survey published early February. The average weighted forecast was estimated at $2,059 per ounce, reflecting the experts’ opinion that there would be no spikes in gold prices. The forecast was only 6 percent higher than the average price in 2023 when the peak value was recorded at $2,078 in late December.
Current forecasts for gold prices are much more radical.
Commerzbank Research expects the gold price of around $2,600 by mid next year, forecasting three interest rate cuts by the Federal Reserve by late 2024 and three more interest rate cuts in the first half of 2025. Bart Melek, global head of commodities strategy at TD Securities, sees the gold price hitting $2,700 in the coming quarters amid the prospects for easing policy by the Fed. The Goldman Sachs’ base-case scenario anticipates the gold price of $2,700 by the end of this year. Finally, Patrick Yip, senior director of business development at the American Precious Metals Exchange (APMEX), expects the gold prices to be $3,000 as early as next year if geopolitical uncertainty persists, interest rates are cut, or global central banks increase their gold purchases.
However, there are cautious opinions, too.
A combination of bearish and bullish factors for gold could ultimately keep the price in a relatively tight range for the rest of the year, says Clyde Russell, an Asia Commodities and Energy Columnist at Reuters. On the one hand, investor interest is likely to be supported by ongoing expectations for monetary easing in key countries, with a particular focus on a probable interest rate cut by the Federal Reserve System, and high geopolitical tensions (ongoing conflicts in the Middle East and Ukraine, as well as the US presidential election). On the other hand, record high gold prices are starting to curb the more price-sensitive part of demand for gold.
China pauses, but its appetite remains unchanged
This is likely already happening now.
This conclusion can be drawn by looking at the data on Chinese gold reserves. The fact is that the share of gold in China’s reserves is disproportionately low, it’s just 4.9 percent compared with the global average of 16 percent. As of 2020, China ranked only sixth in gold reserves, behind Russia, France, Italy, Germany, and the United States. However, China has the world’s largest foreign exchange reserves valued at around $3.22 trillion. In November 2022, several months after $300 bn of the Russia’s reserves were ‘frozen’ due to Western sanctions imposed after the outbreak of the conflict in Ukraine, the People’s Bank of China resumed gold purchases. This followed an over three-year pause in replenishing its gold reserves. According to the World Gold Council (WGC), the Chinese central bank (People’s Bank of China, PBC) was the world’s largest single buyer of gold in 2023, and its net purchases of 7.23 mn ounces were the China’s largest ones over at least 46 years. The active efforts of the People’s Bank of China are practically an advertisement for gold in the domestic market, as retail investors copy the regulator’s strategy.
However, in May and June 2024, the People’s Bank of China’s purchases stopped, putting spot gold prices at risk and leaving the market to speculate on the country’s future plans. In June, China’s gold imports fell by 58 percent to their lowest levels since May, 2022. There were no purchases in July, either.
However, according to Reuters’ that cites an insider involved in the internal discussions, China’s demand is stable, with a tactical pause due to rising gold prices. “But we need to look at prices - it's impossible for the central bank to maintain a constant amount of purchases each month,” the insider said, adding that geopolitical factors spurred by the Russia-Ukraine war and the Middle East conflict were among drivers of China’s gold demand in recent years.
“Given that base and very large scale of FX reserves we believe the PBоC will be buying gold at higher volumes for decades,” said Nitesh Shah, commodity strategist at WisdomTree.
In the second quarter, central banks increased their gold purchases by 6% year-on-year, to 183 tons, in an effort to protect and diversify their portfolios, but this was 38 percent below the previous period, according to the WGC data. Over the first half of the year, global central banks purchased a record-breaking volume of 483 tons, which is 5 percent higher than a year ago. The annual WGC survey showed that the allocation of gold to reserves is expected to continue growing over the next 12 months, due to the need to protect portfolios of gold and diversify them in a difficult economic and geopolitical environment. Nevertheless, the level of central bank purchases in 2024 may be lower than in the previous year (1,037 tons).
It's worth mentioning the structure of demand for gold. According to the WGC, 52 percent of demand for gold for the period from 2013 to 2022 was from jewelers, 26 percent of demand were due to the investments in gold bars and coins, and central banks accounted for 13 percent only. But if the demand from the jewelry sector declines, central banks usually buy up available volumes from the market, which helps in maintaining the demand for gold even during cyclical downturns.
The role of OTC deals
Overall, the global demand for gold in the second quarter of 2024, according to the WGC, was a record one for this period, amounting to 1,258 tons, up 4 percent year-on-year. But excluding over-the-counter (OTC) deals (their volume grew by 53 percent y-o-y, to 329.2 tons), the demand for gold fell by 6 percent, to 929 tons, compared to the same period last year. The OTC market absorbed the surplus supply of gold and became the driver of the price growth. OTC deals typically reflect purchases by institutional investors, high-net-worth individuals, and family funds. The fact that the largest increase was from this sector may indicate the possibility of a slowdown in the coming periods, according to Reuters’ Clyde Russell.
The WGC attributes the surge in interest in gold from institutional and high-net-worth investors to the need for the portfolio diversification. This raises questions about the stability of such demand for gold, as investors will stop buying the precious metal when they feel they have enough gold in their portfolios.
Jewelers and ETFs
At the same time, gold demand in the jewelry sector fell by 19% in the second quarter, to 390.6 tons, due to high gold prices. Investments in gold coins and bars fell by 5 percent year-on-year, to 261 tons, which also suggests that consumers may start decreasing their purchases due to strong increases in gold prices.
The jewelry demand in China and India is of particular concern, these countries taken together account for almost half of physical gold purchases. The demand for jewelry in China fell by 35 percent in the second quarter, to 86.3 tons, while India recorded a 17 percent drop, to 106.5 tons.
The consumer demand in India is likely to pick up in the third quarter after the import duty was cut to 6 percent from 15 percent, although this could prove to be a one-off rather than a lasting shift to higher demand.
Some of the decline in the jewelry market was offset by rising the demand for gold in other industries. In the tech sector, consumption rose 11 percent, to 81 tons, driven by the use of gold in electronics, particularly in AI chips.
Higher gold prices were also likely to effect on exchange-traded fund (ETF) inflows that decreased by 7 tons in the second quarter after falling by 113 tons in the first quarter.
Meanwhile, global gold ETFs attracted $3.7 bn in July, making it the strongest month since April 2022. Inflows were seen in all regions, but Western funds were the leaders, largely due to the political climate in the US. July was an unprecedentedly eventful month, with an attempted assasination of Donald Trump and a withdrawal of Joe Biden from the presidential race. Inflows into gold ETFs increased around both dates, indicating elevated demand for safe haven assets. Macroeconomic factors also played their role, as the US Treasury yields declined and the US dollar weakened, pushing gold prices to record highs during the month and stimulating the investors’ interest in gold ETFs. Equity market volatility, particularly in the second half of July, also supported the demand for gold ETFs, according to the WGC.
Gold supply in the market increased by 4 percent in the second quarter, to 1,258 tons. The gold production was 929 tons, a record one for the period. Recycled gold supplies were the highest for the second quarter since 2012, which was a response to rising gold prices.
Gold as a hedge
We have already mentioned above that private investors’ activity plays an increasingly important role in the global gold market. But what facts should they consider when considering the gold allocation to their portfolios? Over the past 20 years, gold has performed much better than the other classic hedging instrument - bonds, says FT’s financial commentator Robert Armstrong.
That said, the experience of tense periods for gold - from 1997 to 2005 and from 2012 to 2016 - shows that gold is not a source of stable returns. But the important thing is that gold performs well in moments when stocks perform very poorly. This is confirmed by a comparison of the total returns of gold, the S&P 500, and US Treasuries, including treasury inflation-protected securities (TIPS), during four recent market crises:
Armstrong also points out the inconsistency of the trend on the background of inflation. While gold has maintained its value relative to inflation for decades, it may not correlate with inflation or expected inflation during certain periods at all. For example, the gold price soared in 2020 when the printing presses started working, but then traded sideways for several years while the money supply continued to grow.
Another interesting observation is that the price of gold has risen at the start of every US presidential cycle this century.
Gold or gold miners?
The price for gold also looks better than that for gold mining stocks. The FT compares the gold price with a miners’ diversified gold share basket ETF (NYSE Arca Gold Miners Index).
As the chart shows, gold producers have been seriously undervalued relative to the price of their product since 2008. Going back in history, it’s possible to find out that the discrepancy has always been there, it’s been just more telling since 2008. From January 1970 to December 2021, the gold price rose by 4,667 percent, while the Barron’s Gold Miners Index (BGMI) rose ‘just’ by 658 percent. And even taking into account the reinvestment of dividends that most companies pay, the situation remains dire for miners.
What’s the reason?
The discrepancy has always been explained by the stereotype that gold miners are overly optimistic and prone to recklessly build new mines, showing carelessness in the management of shareholder capital. According to John Hartsel of Donald Smith & Co, gold miners lost $80 bn between 2011 and 2015 due to overpaying for mergers or failing to implement their projects. While the industry has examples of the companies like Agnico Eagle that have a tradition of a disciplined approach to capital, the situation is complicated by operating cost inflation. Its rate has outpaced gold price inflation from 2020 to 2022, reducing the producers’ margins, notes Anita Soni of CIBC Capital Markets.
It is the rising cost of gold mining that is the main explanation for this difference in dynamics. Gold miners’ costs for labor, energy and consumables are only increasing under the influence of global inflation and declining gold ore grade, while the companies are forced to dilute shares by holding SPOs to raise funds. At the same time, the price of gold, which is primarily a financial asset, is almost not affected by the growth in the producers’ real costs, since the gold price is determined by central banks and funds.
Sergey Bondarenko for Rough&Polished