A jeweller shows a gold bar at his shop in downtown Kuwait City on May 20.YASSER AL-ZAYYAT/Getty Images
Gold has staged a powerful but baffling rise in recent months. Its big gains force investors to confront a classic market dilemma: Should they pour their money into a rising trend? Or avoid a hot asset because they don’t fully understand what’s driving it?
On the one hand, gold has surged about 14 per cent in U.S.-dollar terms since New Year’s Day. It’s difficult to ignore momentum of that magnitude.
On the other hand, it’s hard to say exactly why the precious metal has put on such a spectacular show.
Consumer prices have plunged in recent months so gold’s rise can’t be put down to jitters over inflation.
It can’t be attributed to worries over impending economic calamity, either.
If anything, the global economy has performed better than expected over the past year. The United States has done particularly well and its booming stock market offers strong evidence that most investors are optimistic about what is to come.
Yet bullion – the classic haven asset, the store of value that is supposed to thrive during the darkest of times – has managed to perform superbly during this sunny patch.
Why? The two most common theories for gold’s attractiveness in recent months are highlighted in a report this week from Man Institute, the British financial research group. The report argues the “main drivers of the gold price have been central banks diversifying away from the [U.S.] dollar and Chinese consumers flocking to safety.”
The first of these factors is probably the most important. When the U.S. decided to freeze U.S.-dollar assets owned by the Russian central bank after Russia invaded Ukraine in 2022, it sent shivers through the global financial system. Many central banks – notably the People’s Bank of China (PBOC) – started to diversify away from the greenback to ensure their own assets could never be frozen in a future dispute.
On top of that, Chinese consumers have turned into enthusiastic buyers of gold. They are seeking a haven for their net worth amid a property crisis and a slide in the Hang Seng key stock index, Man Institute says.
Put both central bank buying and Chinese consumer demand together and gold’s rise since the start of the year appears more understandable.
What is not so clear, though, is how long the gold rush can continue. That would seem to depend primarily upon the state of mind at the PBOC and other central banks. It may also hinge on how confident Chinese consumers feel about their domestic economy. Both factors are difficult to estimate.
A new research paper by Claude Erb and Campbell Harvey of Duke University underlines some of the challenges that face anyone who wants to predict where the gold price is going next.
Mr. Erb and Prof. Harvey show that changes in inflation are not that important in determining the price of gold. What seems to matter more are shifts in the amount of gold held by exchange-traded funds (ETFs). When investors pile into gold ETFs, the price of the precious metal goes up. When investors pull out of gold ETFs, bullion slides.
The researchers also demonstrate that historically there has been a negative relationship between the real price of gold (that is, the price of bullion adjusted for inflation) and the real rate of return on gold over the next 10 years. When the real price of gold is high by historical standards, the real returns over the next 10 years are dismal.
That golden feeling
Exchange-traded funds (ETFs) for gold made their debut a couple
of decades ago. Since then, the inflation-adjusted price of gold has
been closely tied to the amount of gold in ETFs.
Real gold price
(in 1982 U.S. dollars per ounce)
Gold ETF Gold Holdings
(In millions of Troy ounces)
70
$1,000
900
60
800
50
700
600
40
500
30
400
300
20
200
10
100
0
0
1975
1985
1995
2005
2015
2025
the globe and mail, Source: Claude Erb and Campbell Harvey
That golden feeling
Exchange-traded funds (ETFs) for gold made their debut a couple
of decades ago. Since then, the inflation-adjusted price of gold has
been closely tied to the amount of gold in ETFs.
Real gold price
(in 1982 U.S. dollars per ounce)
Gold ETF Gold Holdings
(In millions of Troy ounces)
70
$1,000
900
60
800
50
700
600
40
500
30
400
300
20
200
10
100
0
0
1975
1985
1995
2005
2015
2025
the globe and mail, Source: Claude Erb and Campbell Harvey
That golden feeling
Exchange-traded funds (ETFs) for gold made their debut a couple of decades ago. Since then, the inflation-
adjusted price of gold has been closely tied to the amount of gold in ETFs.
Gold ETF Gold Holdings
(In millions of Troy ounces)
Real gold price
(in 1982 U.S. dollars per ounce)
70
$1,000
900
60
800
50
700
600
40
500
30
400
300
20
200
10
100
0
0
1975
1985
1995
2005
2015
2025
the globe and mail, Source: Claude Erb and Campbell Harvey
So how do things look now? Not great for gold investors. The amount of gold in gold ETFs has declined over the past year. The real price of gold is high. Both factors suggest that gold prices are poised to plunge.
However, there is a rather big “but.” Mr. Erb and Prof. Harvey acknowledge that China’s desire to “de-dollarize” could be a massive, new factor in determining the price of gold. They calculate that if China wanted to establish a greenback alternative, and hold the same amount of gold per capita as the U.S., it would have to hoover up every ounce of gold mined around the world for nearly nine years.
Okay, that is an intimidating thought. But as the researchers also point out, there is no indication that this is actually Beijing’s plan. China could buy up global gold production if it chooses, but it could also cut its gold buying if it perceives other routes to a de-dollarized global economy. If Chinese buying were to dissipate, gold would probably suffer a substantial fall in price.
What should investors do? The high real prices of gold and the decline in ETF holdings suggest caution about gold itself. However, gold-mining shares still look relatively cheap.
Investors who want to bet on a golden future may want to cast an eye over producers such as Barrick Gold Corp. ABX-T, Newmont Corp. NGT-T and Agnico Eagle Mines Ltd. AEM-T They’re far from sure bets, but if central banks continue to buy gold, they will be among the ultimate beneficiaries.