In recent years, gold has shown its ability to continue rising and achieve new historic highs, even in an environment of high interest rates. These high interest rates are, of course, a response to excessively high inflation, which has driven demand for investment gold. Now, with inflation decreasing and central banks lowering rates or preparing to do so, the question arises: Can gold continue its upward trajectory and reach new historic highs, far from current levels? Is gold poised for further growth considering the current fundamental situation, upcoming interest rate cuts, the U.S. presidential elections, and ongoing geopolitical tensions around the world?
Extremely Low Demand Doesn’t Hinder Growth
Looking at data from the second quarter of 2024, the situation appears dire. Jewelry demand is at its lowest since 2020, and overall demand is the weakest since 2021. During these years, demand was weak due to the economic slowdown during the pandemic. It’s worth noting that jewelry demand is the backbone of gold demand, often exceeding 50% of quarterly demand. From 2010 onwards, the average quarterly jewelry demand was around 550 tons, but in the last quarter, it was only 410 tons, and total quarterly demand was just 929 tons. Typically, it exceeds 1,000 tons per quarter. This decline is likely due to high prices, a strong dollar, and economic uncertainty in China. This situation should improve, considering the upcoming wedding season in India, where weddings are traditionally accompanied by significant gold purchases. More importantly, import duties on gold in India are expected to decrease, further boosting demand in the second half of the year. Although overall demand looks weak, there’s no cause for concern, even with a significant surplus, the difference between supply and demand, which was over 300 tons in Q2 2024.
Investment Demand and Central Banks Remain Strong
Despite the weak overall demand, the demand for physical bars and coins remains strong, along with central bank demand, currently forming the basis of gold purchases in the market. These two groups now account for over 50% of demand. Central banks have been significantly increasing their gold purchases in recent years due to economic and geopolitical uncertainty and a desire to move away from the U.S. dollar. Although the dollar remains the dominant reserve asset globally, official institutions aim to diversify their reserves. The People’s Bank of China was one of the largest buyers in recent months, but a recent pause in their purchases caused investor uncertainty, leading to a correction in May, with prices dropping from nearly $2,500 to $2,300 per ounce. However, other central banks have not reduced their purchases. Surprisingly, the National Bank of Poland has become a major player in gold purchases, buying 14 tons in July, bringing its total for the year to 33 tons. This might seem modest, but Poland now trails only Turkey, which occasionally sells gold to stabilize its currency amid extreme inflation. Is the NBP preparing for tougher times? It’s more likely a desire to diversify and achieve a 20% gold share in reserves, currently at about 15%, up from 10% in mid-2023.
ETFs Prepare for Purchases
It’s worth mentioning that about 20 years ago, the first gold ETFs were launched, allowing investors to enjoy the investment benefits of gold without buying bars or coins. These ETFs offer various advantages, such as portfolio diversification and reduced volatility. Buying a gold ETF is akin to a self-fulfilling prophecy: purchasing a unit of an ETF creates a need for the fund to buy physical gold, reducing available market supply and driving up prices. While it’s difficult to pinpoint whether rising gold prices drive ETF purchases or vice versa, the correlation is positive. There have been deviations from this pattern in the past 2-3 years when ETFs were selling gold, but gold prices remained in a broad consolidation phase, with growth continuing last year despite ongoing ETF sales. Historically, investors have bought gold ETFs when interest rates were lowered, and this moment is approaching soon. If ETFs return to their record holdings of around 110 million ounces from the current 82 million ounces, this would create a demand of about 800 tons, potentially reversing the recent surplus.
Are Rate Cuts a Clear Path for Gold?
Lower interest rates mean more money in the market, potentially leading to higher inflation, while gold cannot be printed. Its supply is finite, and annual production generally grows slower than the money supply. This suggests that gold should appreciate in the long term. Looking at gold prices before and after the first Fed rate cut over the past 40 years, the direction is clear. On average, gold gained about 20% two years after the first cut, with only one instance of a loss after two years, and that loss was under 10%.
What’s Next for Gold? Are More Records Ahead?
The year 2024 is unique with the U.S. presidential elections. Although election history does not provide a clear direction for precious metals, the policies of the candidates could lead to further increases. Trump’s tariff policies could drive inflation higher, though this also risks higher interest rates. However, recent years have shown gold’s resilience to high rates. Meanwhile, Harris’s ambitious spending plans could lead to further debt, potentially reducing global confidence in the U.S. dollar.
Although gold is currently at historic highs, its long-term outlook remains optimistic. Inflation has decreased but remains elevated, which will sustain investment demand. The same applies to central banks. ETFs are returning to buying, and investors in the over-the-counter market, futures contracts, and options show strong confidence in further solid gains. While corrections and profit-taking cannot be ruled out, gold will likely continue to perform well in the long term, providing protection against volatility in other assets. Considering the significant overvaluation in the stock market, which may no longer be able to consistently exceed market expectations as it has in recent years, could we see gold prices reaching $3,000, $4,000, or even $5,000 in the coming years? Looking at the price changes in other commodities like copper, oil, or even cocoa, two- or threefold increases are not out of the question.
Author: Michał Stajniak, Deputy Director of XTB Analysis Department
