(Bloomberg Opinion) – Gold has finally broken out of the range it has been stuck in since the start of this decade, hitting a record high of $2,195 per troy ounce this month. While an increase in Chinese buying is likely after the recent rally, some of the more conventional factors that usually drive the yellow metal are starting to fall into line. New records beckon.
China has been diversifying its foreign state reserves into gold for much of the past decade, although reporting of its activity has been patchy. Whether China continues to add at record prices is now a big question, but appetite from the country's wealthy individuals appears to remain unsatisfied.
Switzerland's physical gold exports to China nearly tripled in January, according to the Swiss Federal Customs Administration. This points to Chinese individuals seeking refuge in the oldest form of financial security after a difficult period for the country's real estate and stock markets.
There are other signs that demand for gold is growing more broadly. Analysts at Societe Generale SA reported record monthly fund managers' flows into gold in February, worth $11.3 billion. COMEX gold futures have seen the biggest increase in net new futures in five years in the past two weeks, although exposure is still nowhere near the record for open positions, standing at 426,000 contracts currently versus 550,000 contracts last week. held at the end of 2019.
The decline in holdings of gold-linked exchange-traded funds remains puzzling. These usually closely track the price of gold, but the pairing has changed dramatically since the end of 2022. February saw The ninth consecutive monthly output of physically backed ETFs, with $5.7 billion sold so far this year. However, these outflows have been few the tough demand of the central bankwhich has exceeded 1000 metric tons of purchase per year for two consecutive years.
Gold's performance – or lack thereof — has baffled analysts in recent years. Conventional logic would have predicted new highs when the Federal Reserve ramped up its massive pandemic monetary stimulus program. But the subsequent rise in inflation, driven in large part by rising energy prices, has been accompanied by a decline in correlations of gold with other asset classes. Rising interest rates should have been bad for gold and outbreaks of war would have been helpful, but the reaction was minimal.
According to Chris Watling, founder of investment consultancy Longview Economics, the three main historical drivers of gold prices are the dollar, inflation expectations and interest rate forecasts. They are beginning, belatedly, to assert themselves.
The dollar index has fallen nearly 4% since early November, making the metal cheaper to buy. Inflation has been slowing steadily for a while, so it's hard to give much credit for the recent gold rush. The expert way to track gold's relationship to the monetary side of the economy is to monitor bond yields after adjusting for inflation. The yield on the inflation-linked 10-year U.S. Treasury note has fallen 20 basis points to about 1.8% since mid-February; falling real yields support gold's rise as parking money in bonds becomes relatively less attractive. Meanwhile, the Fed interest rate cut that the futures market is anticipating in the second half of this year should support higher gold prices.
For gold's flaws, its fundamental allure comes from the contrast with currencies backed by nothing more substantial than spendthrift governments. US fiscal deficits, for example, are poised to grow for the next decade, according to the Congressional Budget Office. The accompanying rise in debt issuance will be relentless – adding to the bull case for precious metal enthusiasts. And while Bitcoin's record highs have been fueled by the introduction of cryptocurrency ETFs, the underlying demand driver is a similar disdain for fiat currencies.
Rather than simply wondering whether or not China has bought another truckload of bullion, investors have some less intangible arguments for allocating more money to the metal. Escalating geopolitical tensions, the prospect of tumultuous elections in some countries and an increasingly favorable economic backdrop for gold should pave the way for new highs.
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Marcus Ashworth in (email protected)