Gold made another record close yesterday after its sharp move higher on Friday. That came after softer-than-expected US data and a pullback in bond yields. But the recent surge in gold prices has come even though other factors have been less supportive. That is often a good sign, and shows the market has an upside bias which is underlying and relatively strong. But on a technical basis, prices do look ripe for a correction after two very strong days of buying.
Gold Drivers
Gold has been known for centuries as a safe-haven asset and store of value in times of stress and uncertainty. Investors have historically always liked the assurance of holding the precious metal, as it cushions them from unforeseen shocks. Indeed, the yellow metal hit a record high in December 2023 as ongoing geopolitical risk in Ukraine and the Middle East continued to see buyers flock to gold.
In recent years, a big driver of gold prices has been interest rates. In fact, gold’s relationship with “real” interest rates is worth delving into - those rates are ones adjusted for inflation. Gold and real rates historically have an inverse correlation. That means when interest rates and bond yields rise, the value of the precious metal falls. This is because higher interest rates make non-interest bearing assets like gold less appealing. In effect, they would raise the opportunity cost of holding non-yielding bullion.
Recent Price Action
Last year saw the price of gold hold up relatively well, with safe haven demand battling with both the rising interest rate environment and the mostly stronger dollar. Real yields climbed sharply from a very low base, making zero-yielding gold less attractive. That saw significant Exchange Traded Fund (ETF) outflows in the investment community, but that weaker demand was more than offset by strong central bank buying. A record amount of the precious metal was bought in the first three quarters of 2023 as geopolitical concerns pushed central banks to increase their gold allocation.
Towards the end of last year, markets shifted their central bank expectations sharply, as a drop in inflation and employment indicators saw traders strip back their interest rate tightening forecasts and peg rate cuts across the first half of this year. These expectations for policy easing put downward pressure on the dollar, adding to gold’s attractiveness.
But in the last couple of months, markets have revisited this idea of early rate, as the US economy has performed better than expected. Inflation is also proving stickier in certain areas, particularly due to the enduring strength of the labour market. This has caused services inflation to remain elevated and means there is a higher chance of interest rates having to remain higher for longer.
Going Forward into 2024
Money markets currently don’t give much of a chance of a reduction in interest rates until June, with just three 25bps rate cuts priced in for the rest of the year. The recent GDP release highlighted the resilience in the US economy with growth above 3% in the fourth quarter of 2023, and it appears that momentum has continued into the new year. Inflation has also painted a mixed picture of strength, especially in the monthly data. This macro environment, with the Fed in wait-and-see mode, is not ordinarily positive for gold bugs.
However, investors and markets are forward looking and more hints of economic data rolling over should boost gold prices if more interest rate cuts potentially get priced in again. Positioning by speculators and major investors is also worth noting for future direction. Net long positions dropped at the start of the year and further declines were seen in February as hopes for rate cuts faded while the dollar strengthened. But net inflows could pick up if and when interest rates fall.
Finally, central bank buying has continued this year, with most planning to up their gold reserves in the next year. Reserve diversification and geopolitical concerns are important factors here. Physical demand has also been better than expected in China following the Lunar New Year holidays. Besides this typical seasonal pattern in demand, underlying interest appears robust. Indian consumers too, appear to be getting used to higher prices, with an upbeat economic outlook for 2024 boding well for purchases.