Gold was first used by humans around 4000 BC in Eastern Europe. Due to its rarity and non-corrosive properties, gold attracted lots of attention. Gold was first used for decorative objects, religious items, and jewelry. Gold was first used as currency in 700 BC in coin form by Lydians in what is now modern-day Turkey, creating what was in effect the first form of any monetary system. Throughout history, gold was used as a store of value most often for commerce purposes or as a safe haven. Gold often increased in value during economic uncertainty.
Post-WWII, gold became a hedge against inflation in 1971 when the US ended the fixed exchange rate between the USD and gold. Gold is unique in the fact that it appreciates at the value of future inflation expectations, making it a safe haven when inflation expectations are high.
Within recent years, however, gold has outperformed inflation by a very wide margin, decoupling from long-term interest rate and inflation expectations. Looking at gold prices with a traditional view, this could lead to two possible reasons of thought: First, either gold could be overvalued by 20-50% and will correct down to long-term inflation expectations, or the second thought, long-term inflation rates are too low, and we can expect interest rates over the long term to be far higher. However, there is one other possibility that can be considered once we no longer view gold as an inflation hedge; gold has transitioned away from an inflation hedge and into a repository of enduring value insulated from major economic disruptions. Currently, there is no solid consensus among experts, with some saying gold is a perfect inflation hedge, others saying it's due for a major correction, and others saying it’s now exclusively a safe-haven asset (a repository of enduring value that remains largely insulated from major economic disruptions). The jury is currently out. By looking at recent gold performance, we can get a further grasp on what the asset class is transforming into.
Over a 1 year the S&P 500 and Gold has gained 23.97% and 14.28% respectively. YTD the S&P 500 and gold has performed 8.12% and 11.71% respectively. Over the past year Gold has made great gains, outperforming the S&P YTD by 3%. Recently it seems as if Gol has performed more similar to an equity such as SPX with its growth attracting investors.
The narrative, however, doesn’t necessarily hold when looking at Gold ETF inflows and outflows. While gold as a commodity has gained value, investment in asset-tracking instruments such as gold ETFs has seen a decline as gold appreciates.
Over the past 9 months, gold ETFs have seen major and consistent outflows from their AUM. YTD, gold ETFs have seen a $5.7 billion outflow, lowering to $206 billion in February, declining 1.8% in a month [1]. This, contrasted with gold spot prices, shows that while there is demand for investments in gold, the demand is from physical purchases of the commodity.
2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | |
Jewellery | 616 | 623.5 | 482.9 | 548.6 | 530.6 | 543.4 | 329.4 | 539 | 517.4 | 531 | 535 |
ETF | 0 | 27.8 | 344.05 | 109.6 | 29.2 | 42.9 | 300.8 | -178.5 | 271.7 | -28.57 | -113.7 |
Tech | 83.3 | 83.6 | 76.3 | 78.8 | 81.8 | 79.9 | 72.8 | 81 | 81 | 71.2 | 78.6 |
Banks | 118.8 | 103.1 | 110.6 | 92 | 84.8 | 146.2 | 140.8 | 115.6 | 82.4 | 286.2 | 289.7 |
Bars | 293.3 | 266.8 | 272.3 | 304.1 | 261.3 | 258.3 | 253.6 | 352 | 284.1 | 303.9 | 312.29 |
Total | 1111.4 | 1104.8 | 1286.15 | 1133.1 | 987.7 | 1070.7 | 1097.4 | 909.1 | 1236.6 | 1163.73 | 1101.89 |
Source 2
By looking at the purchase numbers, we can see that the largest increase in purchases is coming from central banks, with a slight increase from small bars
Source 3
Source 4
Looking at the balance sheet of the Monetary Authority of China, it's visible that the Chinese central bank has been increasing their gold reserves over the past year, with 224 tonnes bought in 2023, almost double that of the next country.
This poses a concerning question as to why China is buying large amounts of gold. Some may speculate that this could indicate turmoil, perhaps a near invasion of Taiwan; however, the solution is most likely far more mundane. To see why China is buying up large amounts of gold at unprecedented levels, we must look at Russia and BRICS.
After the Russian invasion of Ukraine, over $300 billion of Russian assets, approximately 60% of the Central Bank of Russia's foreign exchange reserves, was seized by the US. Furthermore, the US froze accounts and seized assets of Russian oligarchs. After seizing these assets, Congress passed a bill using the seized assets to fund the Ukrainian war efforts (source). By targeting assets of Russian individuals and the government, the US was able to greatly disrupt the financial flows and trade of the Russian economy, causing a significant impact. While it was agreed upon on the world stage that a response was necessary, the size and scale of the response caused concern among countries that, while not enemies of the USA, weren’t close allies. While not a physical weapon, the use of economic weapons on this size and scale was unprecedented and extremely destructive, wiping out massive amounts of the Russian economy. This represented a novel and powerful weapon in the US geopolitical arsenal, and the use of it against Russia was effectively a 'Trinity Event'.
While it was not possible for China to wield economic weapons such as this, China, along with many other countries, allied and non-allied, wanted to greatly limit their exposure. As a result of the actions taken by the US, BRICS further emphasized having an alternative to the US dollar, a BRICS currency. Along with BRICS countries, other countries such as Saudi Arabia, the UAE, Egypt, Iran, Ethiopia, and Argentina joined in on the efforts to create a rival to the USD [6].
The main hurdle that BRICS had to face with creating their new currency would be viewed as stable and legitimate, so they settled on a simple solution: a gold standard [7]. While the countries couldn’t transact in gold, they could use investment vehicles and currencies denominated in gold to circumvent US oversight in their actions. An advantage of this is that the countries already have the banking infrastructure built up, so the only additional step would be to create a foreign exchange market that could transact INR to RUB to BRICS gold standard. In doing so, the BRICS nations could create an alternative to the USD, and while incredibly unlikely to be a rival, could act as a workaround to the US financial structure.
Another reason why China is buying gold is more simple: diversification. As previously mentioned, the US was able to seize large amounts of Russian assets. Fearing this, China has begun to sell off large amounts of US bonds [8] and other countries such as India have followed suit (source). As these central banks sell US assets, they are beginning to purchase gold, in their view, a far more stable alternative to US paper.
Looking further into the numbers, we can see that it's not just Chinese and Indian central banks that are starting to have a more positive view of gold. A recent survey done by the World Gold Council shows that “Half of central banks surveyed believe the percentage of reserves in USD in 5 years will be between 40-50%, while just over a quarter believe it will remain unchanged” [10].
It is clear that the future outlook for gold is no longer just an inflation hedge or a safe haven asset. For thousands of years, gold has been a reliably appreciating asset that was widely used and relied on. It was the foundation of ancient monetary structures. Gold was valuable and transacted thousands of years ago and is still valued and transacted today. As currencies and empires and nations came and went over time, the existence of gold was always a common denominator, and it continues to hold its ground as a global standard of value. Central banks are recognizing that gold's value and history of performance make it an incredibly strong strategic reserve asset, capable of reinforcing stability and strength within their economy and balance sheet. This renewed understanding continues to drive participation in the physical gold market and continues to drive the increased valuation of the asset. Once we understand gold's use, we can get a better and more accurate picture of the future outlook for gold values.
While we could look at gold forecasts by institutions made at the start of the year (JPM: 2175, Bloomberg: 1913-2224, Goldman: 2050 [11]), these forecasts have been greatly surpassed as a result of central bank purchasing. To further get an estimate, we must look back at central bank balance sheets and purchases along with future commodity prices.
Source 12
The all-in sustaining costs (AISC) of gold mining have increased partially due to the capital requirements of mining gold. There was a slight drop in AISC due to an increase in grade; however, throughout 2023, there was a large decrease in overall ore grade, causing an increase in AISC [13].Overall, the cost of mining is expected to maintain a slow increase, as previously seen over past years
Currently, China's gold reserves only represent 4.46% of their central bank reserves, with the average East Asian country holding 4.14%, South Asian country at 9.24%, Brazil at 2.6%, India at 8.98%, and South Africa at 14.32% [14]. Based on these figures, along with a rapid acceleration in gold buying, if central banks do hold good to their word on increasing their gold reserves to 40-50%, we should see a massive influx in gold purchases by these banks in the coming months to years.
Recently, even with a large amount of geopolitical noise, volatility levels have remained low. This, paired with potential future interest rate cut probabilities, overall increases the future outlook for gold. The interest rate cuts should increase the overall inflows into gold, and as gold is benchmarked in USD, we can expect to see foreign buying as the cuts cause the USD to lose value. All things considered, holding animal spirits and safe haven catalysts, the price of gold should be expected to rise, with potential for a rather volatile increase in the case of further geopolitical tensions and large purchases by more central banks. The most likely scenario, ceteris paribus, going forward (subjective of course), is that gold will continue to appreciate through 2024 with a slow but stable gain, followed by a surge in price in 2025, spurred by foreign purchases from central banks riding on the back of a lower USD and an increase in domestic purchases as a result of higher leverage.
Sources
https://www.gold.org/goldhub/research/gold-etfs-holdings-and-flows/2024/03
https://www.rferl.org/a/brics-common-currency-challenge-russia-brazil/32571316.html
https://www.gold.org/goldhub/data/2023-central-bank-gold-reserves-survey
https://www.axi.com/int/blog/education/commodities/gold-price-forecasts#:~:text=Gold%20price%20forecasts%202024,-JPMorgan%20Chase%20%26%20Co&text=In%20December%202023%2C%20gold%20prices,the%20final%20quarter%20of%202024.
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