Backed by significant central bank purchases and robust investment demand from China, gold has demonstrated strong momentum this year and rallied 13% through the end of June. We don’t see any change in the persistency in these two secular drivers. What’s more, we see a third driver going forward.
First driver: central banks
Last year marked the 14th straight year of net central bank buying. Central banks’ gold usage for reserve management and diversification has increased as they have sought to reduce over-concentrations in current global reserve currencies (FX reserves) like the US dollar and the euro.
Year-to-date, major gold buyers were all from emerging markets, led by Turkey, China and India. Despite the significant purchases by the PBOC in the past 18 months, China’s current gold reserves as a percentage of its total FX reserves remains quite low at 4.6%.
Other developed and emerging market central banks hold a higher percentage, averaging 60% and 20%,5 respectively, of gold reserves in their total FX reserves. This indicates there is potential for China to purchase more to align its reserve makeup with other similar central banks.
Second driver: Chinese consumer demand
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Chinese investors and consumers have historically shown a strong preference for investing in gold, driven by cultural, economic and strategic factors. Culturally, gold has been deeply ingrained in Chinese traditions and customs, symbolising wealth, prosperity and good fortune.
Economically, gold has served as a reliable store of value, particularly in times when there are fears of currency depreciation, economic uncertainty or volatility. And those economic traits have been reflected in a plethora of macro events restraining local economic momentum, such as:
- The Chinese property market, once a pillar of economic growth, has become a source of concern
- China’s export-driven growth model has come under pressure, as the global shift toward re-shoring and self-sufficiency has led many countries to diversify their supply chains, reducing dependence on Chinese exports
- Chinese government’s regulatory approach has introduced significant uncertainty for investors and entrepreneurs
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These economic challenges collectively led to increased gold demand in 2023 and that same momentum has carried into the first half of 2024. This strength in demand has resulted in the Shanghai-London gold price premium reaching a record average US$39/oz in 1Q2024. China’s physical gold and coin demand spiked 68% y-o-y during the quarter to 110 metric tons, the strongest total for more than seven years.
With restrictions on foreign investments, relatively underdeveloped financial markets with increasing volatility, a real estate market facing many challenges, and local currency depreciation, gold has been viewed as a perceived safe-haven asset and reliable investment vehicle.
As a result, investors should monitor the gold premiums closely and China’s physical gold and bars demand in the coming quarters, as they may serve as solid indicators of when demand from China might start to slow or accelerate further.
Third driver: global macroeconomic landscape grows more fragile
The US economy, aided by massive amounts of fiscal stimulus, continues to defy consensus expectations for a meaningful slowdown. The positive backdrop of determined fiscal and monetary policies and steady economic growth has combined with strong labor markets, growing corporate profits, and healthy consumer spending to create an attractive atmosphere for risk assets.
And much of this favorable environment for risk taking is already reflected in stretched valuations and high asset prices. Many stock markets around the world are at or near all-time highs, credit spreads are historically tight, and most measures of capital market volatility are remarkably subdued.
Looking ahead, market volatility will likely be impacted by the fact that more than 40% of the world’s population is eligible to vote in an election this year.
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November’s US presidential election promises to be one of the closest and most divisive races in US history. Investors should brace themselves for greater election headline risks.
Meanwhile, the probability of a monetary policy mistake has been rising, too. Central banks are desperately trying to find the right balance between inflation and economic growth — all before election noise makes it difficult to meaningfully implement policy decisions.
This is all occurring as ballooning fiscal deficits increase the supply of sovereign debt while demand is falling and central banks lower their purchases for Treasury securities. This likely has contributed to higher and more volatile interest rates than many market participants had anticipated and could destabilize the global economy and result in a stock market correction.
Furthermore, geopolitical tensions in the Russia-Ukraine war, Middle East conflict, and friction between the US and China over Taiwan could damage the global economy and bolster inflation. Rising trade protectionism — like the recent increased tariffs on Chinese imports from semiconductors, solar cells and medical products — likely will hurt the global economy and result in higher prices.
Mid-year gold outlook potential scenarios and trading ranges
Base Case (50% Probability): between US$2,200/oz and US$2,500/oz.
Consumer demand for gold in emerging markets remains steady at current levels, supported by continued robust central bank gold buying. Increasing market volatility from current geopolitical events in the Middle East, Russia/Ukraine and the US presidential election lead investors to increasing gold allocations to manage risks.
Meanwhile, despite the macro headline risks, global and US growth continue to surprise to the upside, limiting rate cuts by the Fed. Declining real interest rates in the US and a weakening US dollar provide support to gold.
Bull Case (30% Probability): between US$2,500/oz and US$2,700/oz.
Central banks’ annual gold consumption comes in substantially above the five-year average of 686 metric tons as recent trends get amplified by geopolitical risks. On the macro front, risks materialise more. High equity valuations lead investors to scrutinisse earnings reports for any signs of weakness or future risk.
This leads to increased volatility against a crowded macro calendar that introduces elevated uncertainty and increasing demand for safe-haven assets. The return of global gold ETF net inflows synchronises with rising COMEX money net gold positions, robust retail physical gold demand and central bank buying to provide support to gold.
Bear Case (20% Probability): between US$2,000/oz to US$2,200/oz
Robust economic growth leads to a higher-for-longer interest rate environment, as the Fed maintains elevated rates to manage inflation and sustain economic growth.
In contrast, global economic weakness prompts central banks in other countries to lower their interest rates to stimulate growth. This divergence in monetary policy creates a substantial interest rate differential that results in an increased demand for US dollars to purchase these assets, driving up the value of the US dollar and creating a headwind for demand.
Robin Tsui is APAC Gold Strategist at State Street Global Advisors
