The contrasts in the gold market are more evident now than ever before. Recently, historical peaks were recorded slightly above $2,430 per ounce, followed by the largest daily loss in years just a few days later. Moreover, gold remains just 5% off its historical highs, with U.S. yields reaching over 4.6% and ETFs holding the smallest amount of gold since September 2019. Given such extremes, does a gold price above $2,300 per ounce seem too high? Or could a reversal of some conditions fulfill some financial institutions’ forecasts of $3,000 per ounce?
Central Banks and Individual Investors Continue to Buy Gold
When analyzing the commodities market, the supply and demand relationship is always crucial. In the case of gold, there has been a persistent oversupply for years, but this isn’t as problematic as it is for oil or industrial metals, which do not share gold’s asset-preserving nature. The largest part of global demand for gold comes from the jewelry sector, often exceeding 50%. However, this demand is relatively stable, or its year-on-year dynamics do not change significantly. There are more notable fluctuations in the demand for physical gold and from central banks. Recently, the share of these two groups rose to nearly 50%, though it was below 50% not long ago. Adding to this are the ETFs that also invest in physical gold, which at one point accounted for close to 60% of the demand. This was the case in 2020, when massive market liquidity triggered by central bank and government actions during the pandemic caused a buying frenzy in many markets. Since then, however, investors have been withdrawing their funds from ETFs, turning instead towards the stock market or even the cryptocurrency market recently. Could a cut in U.S. interest rates change this trend?
The Fed Remains Hawkish But Still Aims to Cut Rates
Gold has maintained high levels in recent months, despite significant interest rate hikes in the U.S. and most of the world’s major economies. This situation has shown that gold retains its value in times of great uncertainty regarding the ongoing fight against inflation. However, speculations about rate cuts that emerged at the end of last year have permanently positioned gold above $2,000 per ounce. Furthermore, in previous years, the anticipation of rate cuts led to increases in gold prices. Therefore, it might seem that a prolonged period of expecting rate cuts could further boost gold prices. However, this situation coincides with the outbreak of several geopolitical conflicts worldwide, which, along with increasing demand for gold, caused its price to continue rising. If tensions remain and interest rates are cut, it could even more stimulate the desire to purchase gold, including from ETFs, which are the last piece in building a multi-year bull market for precious metals.
Does Geopolitics Matter for Gold?
The war between Russia and Ukraine led to gold prices rising above $2,000 per ounce. However, since March 2022, the most important factor for the direction of gold prices has been the behavior of the dollar and yields. The situation changed in October last year when the conflict between Israel and Hamas began, escalating into several other hotspots in the Middle East. Generally, geopolitics has a limited impact on gold in the long term, but if it is coupled with an increase in demand from hedge funds, the situation takes on a completely different shape. Funds have significantly increased their long positions on futures contracts, although their number remains far from the extremely high levels observed in 2020. This shows that there might still be room for further increases, especially when looking at what is happening in China.
China Goes Crazy for Gold
China has long been one of the largest consumers of gold, trying to outpace India in this regard. At a time when the world is trying to move away from the dollar and increase its diversification of reserves, it is turning towards gold. The People’s Bank of China has been buying gold non-stop for 17 months. China is currently ranked 6th in terms of the amount of gold held but is close to overtaking countries like Russia, France, and Italy. Moreover, it is often speculated that the official gold purchases by the PBOC are just a fraction of China’s actual purchases.
The frenzy is also present on the Chinese futures market, where the number of long positions on gold exceeded 300,000 contracts and reached the highest historical values, equivalent to over 300 tons of gold. This is a doubling of long positions compared to the beginning of 2023. This may also be linked to the ban on trading cryptocurrencies and the general trend of seeking safe havens amid ongoing high inflation, the geopolitical situation in the Middle East, tensions between the USA and China, or the upcoming presidential elections in the USA.
What Are the Risks for Gold?
Certainly, a risk for gold prices is the complete de-escalation of geopolitical tensions worldwide, which would reduce demand for safe assets. On the other hand, stock markets remain very much overbought, so market risk remains very high. Another factor that threatens gold and other precious metals is the potential return of high inflation, which would force central banks to return to interest rate hikes. Of course, it can be said that gold, having reached historical peaks, seems to be overvalued, but looking at the metal in relation to the prices of other assets such as copper, oil, the S&P 500, or against the still massive balance sheets of central banks, it seems that gold may still have ahead of it further historical peaks. The level of $2,500 per ounce does not seem far-fetched, and more and more financial institutions are presenting forecasts in which $3,000 appears to be a baseline scenario still for 2024. Of course, any potential investment in gold should only be part of an entire investment portfolio and should be considered in a long-term context. Looking at 5- or 10-year investment periods over the last 30 years, there have been very few instances where the return on such an investment was negative.
Author: Michał Stajniak, Deputy Director of the Analysis Department at XTB
