Gold price skyrockets. Why and for how long? | DW News

Key Concepts

• Emerging Market Central Banks: Central banks of developing economies.
• Gold Reserves: Gold held by central banks as part of their foreign exchange reserves.
• US Dollar Reserves: Foreign exchange reserves held in US dollars.
• G7 Seizure of Russian Assets: The freezing of Russian central bank assets by G7 nations in 2022.
• Jeweler Demand: Demand for gold from the jewelry industry.
• ETF Investors: Investors who buy Exchange Traded Funds, which can track the price of gold.
• Trendiness (Technical Indicator): A measure of the strength and persistence of a price trend.
• Volatility: The degree of variation of a trading price series over time.
• Systematic Strategies: Trading strategies that rely on predefined rules and algorithms.
• Official Institutions: Central banks and other government-backed entities.
• Physical Investment Demand: Demand for gold in the form of bars and coins.
• Futures Positioning: The net position of traders in gold futures contracts.
• Risk Reversal (Options Measure): An options strategy that indicates market sentiment regarding future price movements.
• Risk Assets: Assets that tend to increase in value during periods of economic expansion and decrease in value during economic contractions (e.g., stocks).
• Diversifier/Portfolio Hedge: An asset that can reduce overall portfolio risk by having a low or negative correlation with other assets.
• Core Asset: An asset that is considered fundamental to a portfolio's performance.
• US Federal Reserve Rate Cuts: Reductions in the target interest rate by the US central bank.
• Core Inflation: Inflation that excludes volatile components like food and energy prices.
• Financial Fair Value: The theoretical price of an asset based on fundamental economic models.
• Great Power Competition: Rivalry between major global powers.
• Resource Nationalism: Government policies aimed at controlling or benefiting from a nation's natural resources.
• Supply Chain Resilience: The ability of a supply chain to withstand and recover from disruptions.
• Section 232 Investigations: Investigations by the US Department of Commerce into the effects of imports on national security.
• Critical Minerals: Minerals deemed essential for economic and national security.

Gold's Record-Breaking Rally and Sustained Buying Factors

The price of gold has recently surpassed $4,000 per ounce for the first time, marking its most significant rally since the late 1970s. This surge is driven by several key factors:

• Emerging Market Central Bank Demand: Central banks in emerging markets are increasing their gold purchases to strengthen their reserves. This trend is amplified by a reduced inclination to hold US dollars as reserves, a sentiment that intensified after the G7's seizure of the Central Bank of Russia's assets in 2022.
• ETF Investor Accumulation: For the first time in five years, ETF investors are accumulating gold, rather than selling it in small quantities as they had for the preceding four years.

Analysis of Gold's Momentum and Potential Peak

While gold's rally has been strong, there are indications that its momentum may be reaching a peak.

• Technical Indicator of Trendiness: A technical indicator that measures the strength of a trend relative to its volatility suggests that the current trend is becoming more mature compared to the past three years.
• Increased Volatility: A more mature trend often leads to increased volatility, with more downward price movements interspersed within the upward trend. This doesn't necessarily signal the end of the trend but can make it less profitable for systematic trading strategies.
• Historical Parallels: The period between June and August is cited as an example of what can happen after extreme trendiness. While gold did not experience a significant drop in that period this year, it largely held steady.

Key Buyers and Shifting Demand Dynamics

The demand for gold is coming from various sources, with a notable shift in the primary drivers:

• Central Banks and Official Institutions: This segment has been a significant buyer since 2022, with their gold purchases effectively doubling in size.
• Squeeze on Jewelry Demand: The strong demand from official institutions has, in turn, squeezed out demand from the jewelry sector. Last year, jewelry demand was among the three lowest on record.
• Anecdotal Evidence of Returning Jewelry Demand: In recent weeks, there have been anecdotal reports of jewelry demand returning, alongside a resurgence in physical investment demand for bars and coins.
• Physical Investment Demand: A Japanese refiner has reportedly halted sales of very small gold bars due to insufficient refining capacity to meet demand, highlighting the strength of physical investment.
• Reduced Financial Institution Participation: Financial institutions, hedge funds, and similar entities appear to be participating with less intensity than in the past. This is evidenced by weaker-than-expected futures positioning and a relatively weak risk reversal measure in options markets.

Gold's Changing Investment Case: Beyond Traditional Safe Haven

Traditionally, gold rallies have coincided with stock market downturns. However, this is not currently the case, with strong performance in the S&P 500, bond markets, and a stable dollar.

• Positive Correlation with Risk Assets: Gold has experienced periods of positive correlation with risk assets, notably between 2006-2013 and since 2020.
• Liquidity Generation: During risk asset downturns, investors may sell assets that have performed well, including gold, to generate liquidity.
• Shift from Diversifier to Core Asset: The increasing positive correlation with risk assets potentially diminishes gold's role as a traditional diversifier or portfolio hedge. It may be increasingly viewed as a core asset expected to contribute to portfolio gains rather than solely protect against downturns.

Long-Term Price Forecasts and Underlying Economic Factors

Some analysts predict gold prices could reach $10,000 per ounce by the end of the decade.

• Plausibility of High Forecasts: While speculative, such long-term forecasts are not entirely dismissible, especially considering potential future economic conditions.
• Federal Reserve Rate Cuts and Inflation: The US Federal Reserve is expected to cut rates next year, yet core inflation is projected to remain above target. This scenario echoes previous periods where gold outperformed its financial fair value.
• 2006 Parallel: In 2006, rising oil prices and the Federal Reserve's tolerance for temporary inflation led to gold outperforming its financial model.
• Key Determinants for Higher Targets: The plausibility of significantly higher gold prices hinges on the persistence of core inflation above target and the extent to which policymakers remain tolerant of such an overshoot in the coming years.

Geopolitical Instability and Gold's Safe Haven Status

The current geopolitical climate, characterized by global instability, reinforces gold's traditional role as a safe haven.

• Great Power Competition and Asset Immobilization Fears: A direct impact of geopolitics on gold prices stems from concerns among some governments that their US dollar or euro-denominated assets could be immobilized in future conflicts. This drives demand for gold as a more secure store of value.
• Temporary vs. Lasting Impact of Conflicts: While general conflicts and crises can temporarily boost gold prices, their impact tends to fade within four to six weeks. The fear of asset immobilization due to great power competition is seen as having a more lasting influence.

Precious Metals Rally and Supply Chain Resilience

The rally is not limited to gold; silver, platinum, and palladium are also experiencing price increases.

• Geopolitical Conflict and Competition: This broader precious metals rally is linked to increased geopolitical conflict and competition.
• Pandemic and Supply Chain Resilience: The pandemic has highlighted the importance of supply chain resilience. Governments are increasingly looking to "friend-shore" supply chains to mitigate disruptions.
• Resource Nationalism: This trend can be viewed through the lens of resource nationalism, where governments and companies prioritize securing their supply chains against potential disruptions.
• Examples: China's stockpiling of oil is tightening oil markets, and the US Department of Commerce is investigating critical minerals, including precious metals, under Section 232.

Conclusion

The gold market is currently experiencing a significant rally driven by a confluence of factors, including emerging market central bank demand, a shift away from US dollar reserves, and a return of ETF investor interest. While technical indicators suggest a maturing trend, the underlying geopolitical and economic landscape, particularly concerns about asset immobilization and supply chain resilience, provides a strong foundation for sustained demand. The evolving role of gold from a traditional safe haven to a potential core asset, coupled with the broader precious metals rally, indicates a complex interplay of financial, geopolitical, and strategic considerations shaping the market.