SINCE making a sustained break above US$2,000 per ounce in late 2023, gold has not looked back.
Despite the recent volatility in global markets with the unwinding of the yen carry trade, the yellow metal has remained an oasis of calm. It has not budged much from its level of about US$2,500 per ounce, which also represents a gain of 25 per cent from its price of US$2,000 in January.
Gold is shining bright, and prices may rise to US$2,700 per ounce by mid-2025 and potentially hit US$3,000 per ounce thereafter over the longer run.
Two key factors have been contributing to the strong prices since late last year – safe haven demand amid geopolitical uncertainty, and buying from central banks. The expected cuts in global interest rates present a third factor that is expected to raise gold demand in the months ahead.
The first boost to gold prices comes from the increasing uncertainty in the global geopolitical landscape with two ongoing conflicts in Europe and the Middle East. These geopolitical uncertainties have been supporting the buying of gold.
Coupled with domestic currency depreciation, there have been industry reports of strong purchases of physical gold products such as gold wafers and nuggets by retail investors to hedge against the increasing uncertainty.
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The second factor is the strong reserve allocation into gold by emerging market (EM) and Asian central banks.
China has caught everyone’s attention with its strong allocation into gold.
World Gold Council updates, as at May 2024, indicated that China’s official holding of gold has now risen to about 2,300 tonnes, or just under 5 per cent of total reserves. This is a jump of about 20 per cent from the 1,900 tonnes just two years ago in 2022.
Some of the latest news reports suggest that the People’s Bank of China (PBOC) stopped purchasing gold in the past two months because of the higher prices. However, it is worth noting that on previous occasions, the PBOC had consolidated its reporting of gold purchases by providing a “lumped sum” update at a much later date some months later.
Overall, it is worth noting that on average, EM and Asian central banks hold less than 5 per cent of their balance sheets in gold, compared with developed market (DM) and European central banks which hold on average 10 per cent or more of their balance sheets in gold.
For example, the US Federal Reserve now holds about 8,100 tonnes of gold reserves or about US$625 billion worth of gold under the current spot price of about US$2,400 per ounce. This is about 9 per cent of its overall US$7.2 trillion balance sheet.
Given the elevated risk of global trade conflicts and sanctions, EM and Asian central banks will have strong motivation to play catch-up with DM central banks and allocate more of their reserves into gold.
A recent World Gold Council survey of global central banks concluded that one key reason for EM central banks to allocate more into gold is that it is seen as immune to US dollar settlement risks and sanctions risks.
The Fed’s rate cuts
There is a third factor that is expected to increase gold demand in the months ahead.
With the recent softening of the trajectory of US inflation and the weakening of the US job market, there is now consensus that the Fed will likely start its interest rate cutting cycle from September.
Specifically, we can expect the Fed to make a 25-basis-point (bp) cut at each of the upcoming Federal Open Market Committee meetings in September and December. This will then be followed by an anticipated cut of 100 bps across 2025, at a pace of 25 bps per quarter.
Amid the recent global market volatility, market expectations have gravitated towards an even larger magnitude of rate cuts from the Fed. Long-term Treasury yields have dropped with the 10-year US Treasury benchmark yield dipping from 4.5 per cent in the second quarter, to just under 4 per cent in August.
This anticipated round of Fed rate cuts, coupled with lower interest rates and dropping long-term bond yields, is going to be an important positive driver for gold prices.
Previously, institutional purchases in gold and related investment products were muted because of the high level of interest rates.
Unlike other debt instruments or equity investments, gold does not pay a regular coupon or dividend.
With long-term coupons and returns as high as 5 per cent previously, there was a significant opportunity cost to investing in gold. This opportunity cost is expected to be reduced once the Fed starts to cut rates – and we expect renewed institutional buying of gold in the months ahead.
A key proxy of institutional buying of gold is via gold-backed exchange-traded funds (ETFs). The holdings of such gold-backed ETFs are expected to rise anew in the months ahead as institutional buying returns.
A proven portfolio diversifier of risk
A key motivation of long-term allocation by investors is that gold is a very strong and proven portfolio diversifier of risk. Specifically, gold was a relative oasis of calm in the recent round of elevated volatility in global markets triggered by the unwinding of the yen carry trade.
Despite widespread volatility and the intra-day whipsaw in global markets in early August, gold prices stayed relatively stable around US$2,400 per ounce before strengthening further towards US$2,500 per ounce most recently.
During early August’s volatility, gold’s three-month implied volatility rose in a measured way from 14 per cent to 16 per cent, even as the stock market’s “fear gauge”, the S&P VIX index, spiked above 60 per cent.
With several factors boosting demand, gold can be expected to reach US$2,700 by mid-2025. While it could be premature to look so far ahead, a further rise over the longer term towards US$3,000 is not unrealistic.
The writer is head of markets strategy, global economics and markets research at UOB
