Thursday, 27 June 2024 Reading time : 4 minutes

The price of gold is currently soaring. Since the beginning of the year, the US dollar price of gold has risen by around 12% (as of mid-June), reaching new highs in all currencies. This is by no means typical: the market environment has been characterised by rising real interest rates, a picture in which we would normally expect gold to fall. Indeed, the precious metal is currently playing the role of underdog in Europe and North America, while demand is strong in emerging markets. 

Strong demand despite opportunity cost
Interest rates are usually one of the most important drivers of the gold price - more specifically, it is inflation-adjusted interest rates, i.e. real interest rates, that influence the purchase price of the precious metal. The correlation between these two variables is usually negative: the higher real interest rates are, the cheaper gold is. This is due to the opportunity cost of the precious metal. Since it does not pay interest, investors miss out on the interest income they could earn by investing in bonds, for example, when real interest rates rise. Therefore, so the theory goes, rising real interest rates reduce the demand for gold, leading to falling prices for the precious metal. «The gold price has been well aligned with the interest rate cycle for a long time, especially in the 15-year period between 2007 and 2022,» explains Elias Hafner, Investment Strategist for FX & Alternative Investments at Zürcher Kantonalbank. 

However, this pattern does not seem to apply from 2022 onwards: although real interest rates in the dollar area have increased significantly, the gold price in US dollars has strengthened. There are several explanations for this. What is striking, however, is that gold is particularly popular in emerging markets. «In general, we are seeing a shift in demand towards emerging markets, with both central banks and private investors buying gold,» says Hafner. 

Central banks provide support
Central banks have been one of the biggest buyers of gold in recent years. In 2022, they bought a record 1,082 tonnes of the precious metal worldwide, according to data from the World Gold Council (WGC) (WGC, Gold Demand Trends Full Year 2023). Demand remained strong last year, with central banks again reporting gold purchases totalling 1,037 tonnes. Compared to the period from 2017 to 2021, they have roughly doubled their share of annual gold demand, from 10% to over 20%.

A breakdown of individual buying positions shows that it was mainly emerging market central banks that increased their gold reserves. According to WGC statistics, the People's Bank of China bought 225 tonnes of the precious metal in 2023. This puts the Chinese central bank at the top of the list of gold buyers, followed by the Polish central bank with 130 tonnes. 

Asian private investors are also taking a liking to gold. Hafner notes that there is a lot of interest from China in this segment. He points to the disappointing performance of the Chinese stock market and the real estate crisis as reasons why investors are turning to gold. One measure of investor interest is the demand for exchange-traded index funds (ETFs). As the WGC data shows, global holdings of gold ETFs have shrunk over the past year. However, investment behaviour is diverging in different regions of the world, and while investors in Europe and the US have been withdrawing money, gold ETFs in Asian markets have seen net inflows.

Gold rally takes a breather
The gold rally has lost some of its momentum in recent weeks. «Gold is currently in a consolidation phase which could last a little longer,» says Elias Hafner. However, he does not expect any major setbacks as underlying demand is very strong and central banks could use price setbacks to buy more. 

Whether investor interest in Europe and the US will revive will depend on a number of factors, including future monetary policy. Global political and geopolitical developments also play a role. If uncertainty increases, for example driven by escalating conflicts, gold is likely to benefit from its status as a crisis-proof investment. It remains to be seen whether the gold price and real interest rates will return to their traditional pattern in the future. 

Investing responsibly in gold
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Disclaimer
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