Gold is regarded as the ultimate store of value. But over the years, the king of safe haven trades has largely been neglected as markets have favoured risk assets in search of above average, or alpha, returns. Until 2024 – the year that sparked a record-setting rally in the price of the yellow metal.
Investors kicked off the year with the expectation that the US central bank, the Federal Reserve, will cut interest rates at least six times. This belief turned out to be a false conviction. But that did not prevent gold from rocketing higher even as markets today know they are not going to see their dreamed-up narrative play out in real life.
Economics as the reason
Gold is a non-yielding asset, which means that it does not generate a passive income to its holders. But gold increases its appeal whenever there are prospects for changes in the fixed-income landscape. Why is that? High interest rates help generate attractive fixed-income returns. The US dollar, for example, has the ability to yield returns, which get higher when interest rates go higher.
If history has taught us anything about gold, it’s that it’s a safe haven asset
That is part of the reason why investors may choose to increase their dollar holdings in a high-interest rate environment. But when that tide shows signs of turning, money managers can pivot to gold in bets to capture better returns on their investment.
A low-interest rate environment is generally beneficial to gold because it diminishes the opportunity cost of holding a non-yielding asset. In other words, investors are not going to miss out much by offloading their dollar positions.
Further, stubborn inflation in the US has upheld the hedge-against-inflation narrative for gold. Once markets realised that consumer prices were not going to go down without a fight, they were quick to rush back to the yellow metal, boosting its price in the process.
History as the reason
If history has taught us anything about gold, it’s that it’s a safe haven asset. For hundreds of years, gold has been valued based on its scarcity and investment appeal. Unlike fiat currencies, which can be inflated due to the issuance of new amounts, gold tends to retain its value and remain stable in the face of inflation pressures.
This intrinsic property makes it a reliable store of wealth in times of excessive, or ‘runaway,’ government spending, rising inflation, and clouded interest-rate prospects. And in 2024, market participants saw it in action. When investors worried over the stability of the global status quo, they chose to scoop up loads of the precious metal.
The upside trend was not without any hiccups along the way though. Anytime there was a shift in expectations, gold prices would react. If markets suddenly believed economic pressures were easing and rate prospects were bright, they would pare back their gold bets, leading to price declines. One market participant, however, was not that easily convinced in the downside scenario.
Central banks as the reason
Central banks are institutions set up to manage and control the money flow in the economy. They are mainly tasked with the responsibility of maintaining price stability and healthy levels of employment.
These are also the entities that print money. They are the only legal institutions which have the authority to issue and regulate a nation’s currency. Central banks oversee the printing, minting, and distribution of banknotes and coins. And they are some of the biggest buyers of gold.
Gold is a mainstay asset for any central bank reserve because of its stability, liquidity, and potential returns. The World Gold Council – a leading gold-focused trade association – estimates that around one fifth of all gold mined throughout history is held by central banks. In 2023 alone, they purchased more than 1,000 tons of gold, crossing that threshold for the second year in a row. Consistent central bank purchases are placing a stable floor under gold prices.
To better understand the scale, all the gold ever unearthed is around 212,000 tons. One way to picture that is that it’s the equivalent of roughly 64,200 Tesla Cybertrucks. For the curious minds, the biggest holder of gold today is the US government, owning more than 8,100 tons worth over $600bn, while the entire gold market is worth roughly $16trn.
Geopolitics as the reason
Geopolitical risks are a major driver for upside swings in bullion. There are only a handful of assets considered safe havens during uncertain times and gold is the long-standing number one among them.
In the current landscape of geopolitical tremors in the Middle East, markets fled to the perceived safety of gold, helping buoy its price as soon as the first signs of trouble appeared in early October 2023. The turmoil between Israel, Gaza, and adjacent or involved powers shook up the global investment landscape and prompted a massive reshuffling of assets as investors rotated their portfolios to risk-averse mode.
Historically, when geopolitical tensions escalate, traders and investors pivot away from risky assets, such as stocks, and increase their allocations to gold as a hedge against unknown risks and possible global shake-ups.
Supply and demand as the reason
Gold prices are moved by a mosaic of factors, including all the ones listed above. But supply and demand stand out as a keyway to gauge investor appetite for bullion and even anticipate where the metal might be headed next.
Supply and demand trends underpin how gold performs. When supply outstrips demand, prices may move lower as there is more gold available than markets are looking for. And vice versa – when demand outweighs supply, prices may chart an upward trajectory because there is not enough for everyone who wants a piece.
A recent example is the pronounced demand from Chinese customers who were on the hunt for a safe place to park their cash amid a meltdown in the local property market. Furthermore, the Chinese stock market has been in a notable slide this year, prompting fiscal interventions from officials in efforts to shore up confidence and provide stability. Chinese investors flocked to gold as a way to protect their cash and allow for upside amid a troubling market environment at home.
Is it different this time?
Gold’s rise this year has one curious attribute that makes it different than similar increases in the past. This time the US dollar is rallying together with it. Usually, whenever gold would gain ground, it would do so at the expense of a weakening greenback. This is because gold and the dollar have an inverse correlation – when one rises, the other tends to fall. But the forex space has been dominated by dollar strength in recent months.
Around one fifth of all gold mined throughout history is held by central banks
The American currency has surged this year, outperforming just about every one of the major currencies, such as the euro, the British pound, and the Japanese yen. This resilience is underpinned by the higher-for-longer rate narrative. In other words, interest rates staying elevated is keeping the US dollar well-bid and floating relatively high on the forex board. But that is not stopping gold from rising as well. In the span of early October 2023 through mid-April 2024, gold added more than 30 percent to its valuation, crossing the never-before-seen level of $2,400 per troy ounce. The spectacular rally eclipsed nearly every other mega-cap asset’s performance. America’s broad-based S&P 500 index climbed just over 20 percent in the same period.
What about silver?
Silver is often referred to as ‘poor man’s gold’ for its role as a more affordable safe haven alternative to gold. The global silver market is gravitating toward a capitalisation of roughly $1.5trn, or more than 10 times less the overall valuation of gold.
Despite the big price-tag difference in these two markets, silver did not enjoy a breakneck buying momentum when gold whizzed through a full-on buying bonanza. In fact, it missed out on a record-setting rally while gold was having one.
Apparently, investors did not favour silver and chose to stick to the classic choice anytime uncertainty rattles broad markets. But that does not mean there can’t be a catch-up play for the smaller haven trade. All it would take is for investors to decide that the gold market has become frothy and that a correction is on the table. Given the smaller market capitalisation, it would take less capital inflows for silver to peak at a new all-time high, compared to the financial muscle needed to keep pushing gold prices to new records.
