The Drivers Behind The Gold Price Surge

(March 28, 2024 - UBP - Union Bancaire Privée)

At the beginning of March, gold prices rose aggressively, moving from levels of around USD 2,050 to all-time highs of above USD 2,200 per oz. There were several drivers behind this upward move.

First, inflows towards the financial gold market surged, and there was a notable increase in long futures positioning, suggesting that institutional investors had increased their exposures towards the yellow metal. Second, central banks continued to aggressively purchase physical gold and the latest data show heavy purchases since the beginning of the year of around 40 tonnes per month. We think that central bank purchases are having a material impact on the market. The World Gold Council believes that prices are around 15% higher as a result of ongoing central bank purchases. This trend is likely to continue over the coming months and years, as central banks move to increase their gold reserves. Third, retail investors increased investments in gold exchange traded funds (ETFs); however, the increase in retail positions took place following most of the upward move. This widening of the investor base implies that this move has further to run. We note that retail investors remain underinvested compared with historical averages.

The major central banks indicated that they are set to begin reducing interest rates over the coming months. The latest indications are that central banks will have a front-loaded rate-cutting cycle, meaning that nominal rates will decline substantially this year. The coincidental and rapid decline in global inflation dynamics, combined with a front-loaded rate-cutting cycle from many of the major central banks, is a highly constructive development for gold. This explains the rapid upward move to levels above USD 2,200 per oz.

Coming into the second half of the year, we have identified two potential drivers of higher prices. First, the US presidential election campaigns will likely serve to highlight excessive debt levels in the US, and increasing concerns about US fiscal sustainability will be beneficial for gold in our view. Second, we think that geopolitical risks will remain elevated and any worsening in relations between the major powers will give an upside skew to gold prices.

The only caveat that we have regarding current pricing is that gold has come a long way in a short period of time. It currently trades with an enormous premium to ten-year Treasury Inflation-Protected Securities (TIPS) yields, which we view as a proxy for forward-looking real interest rates. This large premium could contract if TIPS yields fall over the coming months, which is feasible if the Federal Reserve begins to cut interest rates. This means that forthcoming Consumer Price Index (CPI) prints in the US will be highly important. If CPI readings show some moderation on a monthly basis, we can expect that gold will trade at or slightly higher than current levels.

Overall, we maintain a constructive stance on gold, and any dip below levels of around USD 2,100 per oz is a strong buying opportunity in our view. Over the longer term, a move towards levels of around USD 2,300 per oz is feasible.