But this rapid rise to all-time highs is even more interesting given who did, and didn’t, contribute to the price jump. Ask investors about gold as an investment and it’s like conducting a Rorschach test – the psychological appraisal in which people project their unconscious thoughts onto inkblot images.
Macro investors will tell you that the gold price rises as real interest rates fall. Meanwhile, others will concentrate on the intricacies of supply and demand.
Gold has been around as a monetary asset for more than 5,000 years; you would think some consensus would have developed in that time.
But buyers can be motivated by different issues.
International politics
Gold is sometimes considered a haven during times of geopolitical uncertainty. The recent surge in gold prices can be attributed to growing sophistication of emerging economies and their efforts to minimise risks to their economic prosperity.
- Gold as alternative to US dollar. Many countries are reducing their foreign exchange reserve holdings of the US dollar and US government bonds. One of the reasons for doing this is to reduce vulnerabilities linked to access to SWIFT, the international money transfer network. Western countries can restrict access to SWIFT to enforce economic sanctions and have been doing so since the start of this century.
- BRICS expansion. Six more countries joined the group of emerging market nations last year and another forty have applied for membership. A bigger BRICS offers a counterbalance to Western influence and reflects the desire for economic power to shift towards other parts of the world. China – a key member – would like to see a global financial system that relies less on the US dollar.
Chart 1: Gold price vs known gold ETF holdings
Source: Bloomberg, 19 September 2024.
Markets, bullion
As the battle against inflation takes a back seat to efforts to achieve full employment, interest rates are falling around the world and gold looks increasingly attractive:
Interest rates and investor behaviour. Gold does not pay dividends or interest. There is an opportunity cost to holding gold and this makes it vulnerable to changes in real interest rates (rates adjusted for inflation). Over the past two years, investors sold more than 810 tonnes of gold as real interest rates rose. But when real interest rates fall, gold becomes more attractive.
The US Federal Reserve (Fed) finally cut a key interest rate by 50 basis points last month to join central banks in Europe, the UK, and China in monetary policy easing. Investors have just begun to add more gold to their portfolios from very low levels. Investments in exchange-traded gold funds (ETFs) picked up in June – equivalent to some 2.5 million troy ounces between May 28 and September 19 – in anticipation of the Fed cut.
During the last three rate-cutting cycles in the US, gold rose 57%, 235% and 69% respectively starting in 2000, 2006 and 2018. A pickup in investor demand was largely driving these increases so they are key to the future gold outlook.
Official sector purchases. Following the 2007/08 global financial crisis, the Bank of International Settlements, as part of the Basel III regulatory framework, allowed banks to count 100% of gold's market value on their balance sheet (up from a 50%-allowance).
This enabled banks, especially central banks and national treasuries, to more easily accumulate larger amounts of gold. In the roughly 24 months to December 2023, ‘official sector’ purchases of physical gold totalled some 2,100 tonnes. In fact, 2022 and 2023 were the number one and two biggest years for purchases of bullion by such buyers. These purchases look set to continue.
Economic strength, weakness
Two of the biggest economic success stories of recent decades have been China and India. The rise of the middle class in both countries has boosted the spending power of people who are keen to flex their newfound economic muscle.
Consumers in both countries value the yellow metal as a store of value – an integral component of household wealth – and as a customary gift at landmark events, such as the birth of children and weddings. Gold is especially prized during times of uncertainty:
Retail demand. In western cultures, jewellery is typically prized for its aesthetic appeal. However, in India and China, gold is often purchased as a store of value to be kept in a safety deposit box. That’s why the two countries’ ‘jewellery’ purchases can account for up to a quarter of global demand for gold. Most recently, India's decision to cut taxes on gold to 10-year lows may boost retail demand there. Chinese consumers, faced with falling property prices and limited places to park their money, have also turned in greater numbers to the yellow metal.
Final thoughts
The price of gold has been on a tear, lifted by strong demand for the physical metal by central banks. But now demand is set to rise in India due to lower import duties, while global investor demand for gold has historically risen after interest rate cuts.
As countries diversify even slightly away from US dollar assets, central banks increase their gold reserves and investors respond to changing interest rates – demand for gold is likely to remain strong for some time.