Between the headquarters of the US central bank in Washington, D.C. and the Grasberg Mine on the island of Papua-New Guinea are the entire North American continent and the Pacific Ocean. The distance of around 15,000 kilometres as the crow flies does not change the fact that the Fed’s decisions have a direct impact on the world’s biggest source of gold – at the end of 2022 its owners estimated the proven reserves at more than 26 million ounces. Current US monetary policy is actually anything but favourable for the profitability of this “treasure trove”. In the fight against inflation, the FED has increased its base rate from almost zero in March 2022 to the present 5.25% to 5.50% range. During this time the price of a troy ounce of gold has proved relatively stable on balance, albeit with some fluctuations.
At first sight this trend might seem astonishing, given that rising returns are “toxic” for gold investment per se because the yellow metal does not offer any ongoing income. To that extent the opportunity costs for owning gold rise with interest rates. On top of this is the fact that the US dollar has appreciated sharply against other major currencies during the latest cycle of rate increases. The greenback is actually regarded as a contra-indicator for gold, with a USD appreciation typically making the precious metal more expensive for buyers outside the dollar zone. “Gold and silver prices remain resilient in the face of higher US real yields and a stronger US dollar,” the Global Commodities Research team at J.P. Morgan stated. In the view of the analysts, this is nothing new: the negative correlation of gold to USD real yields had also weakened during previous FED hiking cycles. As soon as the US central bank pressed the pause button or lowered interest rates, the asymmetry became more pronounced again.
“This momentum has contributed to the recent resilience of gold and also underpins our projection of new record highs in 2024,” the analysts wrote. Alongside the connection to USD yields and the dollar exchange rate, they cite purchases by central banks and geopolitics as further grounds for the stability of prices since 2022. Indeed, the recent attack on Israel by Hamas, the radical Islamist group, has only underlined the status of the precious metal as a safe haven, with the price of a troy ounce climbing by more than 5% within the space of a week. Global currency watchdogs had already taken bold action long before the escalation in the Middle East. According to figures from the World Gold Council (WGC), last year central banks bought 1,082 tonnes of gold in total, the biggest amount since records began in 1950. Although the pace has abated somewhat just recently – the Turkish bank, for instance, was actually selling gold in the second quarter of 2023 – the WGC still reported record levels of central bank purchases totalling 387 tonnes in the first half of the year, not least due to greater activity on the part of the People’s Bank of China (PBOC).
Meanwhile, physically collateralised Exchange Traded Funds (ETFs) have been posting net outflows for a number of quarters now. According to J.P. Morgan, this could change as soon as the price of gold heads towards an all-time high. The historic peak of the troy ounce stands at USD 2,072.50, achieved in August 2020 during the initial phase of the coronavirus pandemic. J.P. Morgan expects the yellow metal to jump above this level in the second half of next year: the US bank sees an average price of USD 2,175 in the fourth quarter of 2024. The year after, gold could even be trading at a mean USD 2,250. The fulcrum of this optimistic forecast is US monetary policy. The Fed has recently has been sounding hawkish, telling the markets to prepare for “higher for longer”, i.e. that interest rates could remain at a higher level for longer. Nevertheless, J.P. Morgan reckons the cycle of hikes has ended. “Our economists expects the next Fed step to be a cut of 25 basis points in interest rates in the third quarter of 2024,” the Commodities Research report stated. Although the “higher for longer” debate could put a brake on the precious metal in the next few months, J.P. Morgan is well and truly in the bull camp looking ahead to 2024. Of course, this optimism is not without its risks: in particular, stubbornly high inflation allied to solid US economic data could push interest rates up again, putting gold under pressure.
Source: Bloomberg Past performance is not a reliable indicator of future performance.
Source: World Gold Council; as at: October 2023. Past performance is not a reliable indicator of future performance.