Western buyers are returning to the gold market

The price of gold has surged at nine times the rate of UK inflation over the past 20 years whilst growing much faster than the price of real estate. With the price of gold rallying to an all-time high of $2,531.70 recently, the commodity’s reputation as an inflation-hedge seems truly deserved.

In July 2024 the average price was over six times higher (525%) than 20 years earlier, jumping from $391 to $2,446 per ounce. The UK’s consumer price index (CPI) rose by 57% over the same period.

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The precious metal has also proven to be a far more lucrative investment than real estate. Whilst UK property prices rose 93% from July 2004 to June 2024 – easily beating inflation – the price of gold increased more than five times faster.

Because gold pays no yield, but offers an inflation-proof investment, its price typically shows a strong negative correlation against real interest rates. To track this, analysts and traders tend to look at the yield offered by 10-year US inflation-protected Treasury bonds. That correlation is now back into deeply negative territory after defying the usual pattern and nearing its most positive in almost two decades this spring.

The gold market is changing its tune

Late-2023 and spring 2024’s big surge in gold prices came despite Western investment flows turning negative.  This defied a widely-assumed basic for how the gold market works. As a proxy for wealth management flows, analysts and traders usually add the size of gold-backed Exchange Traded Funds to the level of bullish betting by speculative traders in US futures and options contracts.

Gold’s 12-month r-squared correlation against the gold price shows a long-term average of 66.9%. After sinking to a historic low of 0.1% in February 2024, it has now rebounded to a statistically significant 58.9%. Within ETFs, inflows have flipped from Asia-listed funds – where investors are now net sellers as a group – to Western markets.  Western demand has been positive for eight weeks running, led by the US, UK and France.

Softer demand for gold in Asian markets

After driving gold’s new all-time highs in the first-half of 2024, household and investment demand in China has sunk in the face of the precious metal’s latest record highs, most especially for jewellery. This means Shanghai prices have now been trading below London quotes for almost two weeks, the longest stretch of discounts since summer 2021, as the People’s Bank relaxes the tighter import quotas it imposed two months ago (most likely to try reducing pressure on the Yuan’s FX rate).

Prices in number two consumer India have also gone back to a discount vs. global quotes after briefly turning positive in July. Again that suggests softer demand.  But July’s surprise (and large) cut to import duty in the BJP’s post-election budget is likely to support if not boost wedding and Diwali festival demand.

Even at record high prices and even with the Rupee near record lows on the FX market, gold will find eager buyers in the world’s fastest-growing major economy now that the Modi government has halved total tax costs from 18% to 9% on gold sold at retail.

Profit taking by central banks

Like China’s private-sector demand for gold in the 12 months to June, central banks as a group broke with their typical behaviour in the past few years to buy gold even as prices rose to new all-time highs. Led by China and other emerging-market nations, this demand helped support and boost prices even as Western investment went AWOL.

But while the Reserve Bank of India has continued to accumulate bullion, China has reported no additions since April.  That snaps what may have been planned as an 18-month programme of gold reserves growth. At the same time, official data for June show Mexico, Kazakhstan and most dramatically Singapore and Turkey taking profit. This has lead to the first net selling in more than 12 months.

Major de-dollarization trend

The return of Western gold investment demand has, to date, been less dramatic than its impact on gold prices. Gold ETFs plus Comex net speculative betting combined have expanded by 16% from six months ago; the price of bullion has gained over 22%.

Weaker competition for savings and investment from cash-in-the-bank and bonds will support new inflows to gold. Lower interest rates will also encourage fresh speculation in gold derivatives by reducing the cost of carry. With investor positions (ie, ETFs + Comex) still 1/10th below the pandemic peaks of 2020, there’s scope for the trend to accelerate as interest rates fall, not least with November’s US election guaranteed to be inflationary thanks to higher budget deficits and trade tariffs.

Trump or Harris, the US election won’t ease tensions with China nor over Ukraine or the Middle East. Against the backdrop of Washington’s ever-growing debt mountain, that will support de-dollarization and gold-buying by central banks, perhaps with more dynamic trading if prices spike amid post-election volatility in the currency markets.

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