The precious metal is proving a haven from global uncertainty even as inflation cools.

In the decade or so after the fall of the Berlin Wall in 1989, gold hovered between US$255 and US$410 an ounce, well down on its peak in 1980 of around US$690¹. Gold fell for two reasons over the 1990s. One was the end of the Cold War reduced its appeal as a haven from global tensions. The other was that lower inflation removed its attraction as a hedge against rising prices. In more recent decades, gold formed an inverse correlation with real interest rates. The lower real yields fell, the higher the gold price, and vice versa. However, this relationship snapped in early 2022. When real yields rose, gold didn’t decline from about US$1,800. In fact, gold kept rising and in May hit a record high above US$2,400.

Why is gold soaring now? Two reasons. One is the world is a riskier place. The relationship between China and US has deteriorated. Russia’s invasion of Ukraine in 2022 – the incident that broke the correlation between gold and real rates – has reverberated through Europe. Conflict has erupted in the Middle East. The insecure global environment has created two types of gold-buying countries. One group is vulnerable countries such as the Czech Republic and Poland that, via their central banks, are building gold reserves as a form of insurance against turbulence in their regions.

The other group is US foes such as China and Russia. A big motivation is their desire to escape Washington’s ability to weaponise the US dollar. Washington can employ financial coercion against adversaries because the US dollar plays an unprecedented role in the world’s global financial and trading systems. In May, the US Treasury’s Office of Foreign Assets Control had 38 ‘active sanctions programs’ in place. These programs target countries, companies and individuals for human-rights abuses, supplying narcotics, conducting cyber warfare, violating borders and more.²

Among the sanctions inflicted on Russia after it invaded Ukraine was the unprecedented decision to freeze half of Russia foreign-exchange reserves. This move destroyed the belief that Washington wouldn’t dare touch forex reserves for fear of undermining faith in the US-led financial system. US adversaries think they need to ‘de-dollarise’ to escape Washington’s financial reach. That means holding fewer US-dollar-denominated securities as reserves and using other currencies for trade. The BRICS countries (Brazil, Russia, India, China and South Africa) talked about a new common currency for themselves and others when they met in August last year. This gave rise to talk China is seeking to create a gold-backed common currency.

This view has gained traction because the central People’s Bank of China has bought gold every month from October 2022 to March this year, its longest buying spree since at least 2000. China’s gold reserves have jumped 16 percent over the 17 months to a record 2,262 tonnes, the World Gold Council says³.

Why now? As well as a longer-term plan to de-dollarise, could China be insulating itself from the Western sanctions it would face after any attack on Taiwan? Then there are the economic reasons why gold demand is strong. One stems from concerns that record high government debt across the world could spark fiscal crises. Rising interest rates mean governments must allocate a larger portion of their budgets to interest repayments. Of particular concern is that Washington’s reckless finances could undermine the US dollar. IMF figures show Washington’s debt is about 120 percent of GDP and the federal government is running a fiscal deficit equal to 6 percent of output this fiscal year.^[4]

The other source of economic-related gold demand is that China’s property crisis and plunging share markets have prompted Chinese investors to buy gold for its perceived attribute of being a store of value.  We hold a bullish position on gold in our strategic portfolio. We expect the strong demand for gold from central banks and Chinese investors to endure. More speculators are expected to take punts on gold rising further. It’s likely too that the long-standing inverse relationship between real yields and gold will be revived when investors price in rate cuts as inflation slows toward central-bank targets.

[1]Goldprice. goldprice.org/gold-price-chart.html

[2]US Treasury’s Office of Foreign Assets Control. ‘Sanctions programs and country information.’ ofac.treasury.gov/sanctions-programs-and-country-information

[3]World Gold Council. ‘China’s gold market in March: official gold reserves rose further, wholesale demand fell slightly,’ 15 April 2024. gold.org/goldhub/gold-focus/2024/04/chinas-gold-market-march-official-gold-reserves-rose-further-wholesale.

[4]Congressional Budget Office. ‘The budget and economic outlook: 2004 to 2034.’ 7 February 2024. cbo.gov/publication/59710