Why the sudden shine in gold again?

There has been a sudden shine in gold again and investors are wondering what is behind the recent rally in the gold price. There were some significant upward moves in the gold price over the past few months, with the yellow metal reaching an all-time high of $2,450 per ounce in May 2024, with a year-to-date return of 13.0% and a return of 19.5% over the past 12 months to the end of May.

Gold has a history as an investment and may fulfil a potential role in providing protection against an equity market decline as a possible inflation hedge. Including the yellow metal in a portfolio can improve long-term returns or risk-adjusted performance, Michael Dodd, senior investment analyst at Morningstar South Africa, says.

“What is interesting about the recent surge in the gold price from late 2022 to early to mid-2024 is that it came during a period when market participants would not have expected the yellow metal to rally significantly.

“Gold prices tend to be negatively correlated to real interest rates. The lack of cash flow generated from gold increases the opportunity cost to hold it as interest rates rise and the opportunity cost to fall as interest rates fall.”

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Real interest rates increased as Fed hiked rates

What you can see from the red bars in the left chart above is that real interest rates increased significantly since the US Federal Reserve started hiking interest rates aggressively, starting in March 2022, to tame rampant inflation, Dood says.

“This coincided with strong upward movements in the gold price, which is a bit of an anomaly when looking at the inverse relationship between real interest rates and the gold price that has persisted historically.”

Another interesting observation is that the recent rally in the gold price coincided with a period of outflows from gold ETFs, which is evident from the red bars in the right chart above, he points out. “The previous strong run-up in the gold price in 2019 and 2020 was supported by strong inflows into gold ETFs although the recent rally does not appear to be supported by gold ETF purchases.”

What is then behind the recent rally in the price of the yellow metal? Firstly, Dodd says, it is worth highlighting that there has been an obvious increase in geopolitical risks due to the ongoing wars, starting with the Russian invasion of Ukraine and then the outbreak of hostilities in the Middle East. This has driven the demand for gold, which is often viewed as a safe haven asset.

He says other factors affecting the demand are macroeconomic uncertainties created by high global inflation, concerns over the global recovery from the pandemic lockdowns and more recently, worries over the outcomes of the numerous national elections taking place in 2024.

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Central banks buying gold

“As the graph above highlights, unusually high central bank buying of gold also contributed to the precious metal’s record highs. In 2022 and 2023 over 1 000 tonnes of gold were bought, compared to the historical average of around 400 tonnes.”

Dodd says if we drill down a bit further, the most notable central bank purchases over the past 4 years appear to be coming from the People’s Bank of China, the Reserve Bank of India and the Central Bank of Turkey. Their reported primary reasons for purchases have been gold’s value in times of crisis, its benefits of diversification and being a long-term store-of-value and inflation hedge.

The recent surge in central bank purchases of gold since 2009 and a rising gold price has grown the precious metal’s share of global international reserves to the detriment of fiat currencies, Dodds points out. “While the US dollar still dominates the share of global international reserves, gold has now surpassed the euro as the second most dominant portion of global international reserves.

“If we reduce the analysis to simply focusing on the US dollar and gold’s share of global international reserves, it appears to indicate that the US dollar’s share of global international reserves is trending lower, while the yellow metal’s share is increasing.

“The reduction in the share of global international reserves held in fiat currencies may be caused by declining trust in “credit assets” due to worrying asset bubbles, escalating sovereign debt, the breakout of major wars and inflation fears. This appears to be driving the continued demand for gold rather than fiat currencies and it will be interesting to see whether this trend continues going forward.”

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Gold price driven by central banks of China, India and Turkiye buying

Dodd says it is interesting to see the recent rally in the gold price was not supported by positive movements in real (after inflation) interest rates or flows into ETFs. “Instead, the strong upward moves appear to be driven by central bank purchases of gold in China, India and Turkiye, as well as some other Asian and Eastern European countries.

“The recent rally in the gold price, as well as the increase in central bank purchases has increased gold’s share of global international reserves, with gold surpassing the euro as the second largest component of global reserves. While the US dollar still maintains a healthy lead in terms of its share of global international reserves, the trend appears to indicate that gold may be gaining ground at the expense of the greenback.”

What is Morningstar’s view on gold as an investment then? Dodd says the introduction of the yellow metal in a portfolio is not guaranteed to improve risk, returns or risk-adjusted returns for every period based on historical evidence.

“Rather, the track record of the precious metal is mixed and gold can go through long periods of underperformance. The strongest evidence for holding gold appears to be a safe haven in periods of significant market volatility.

“Our current view is that it should be viewed as an insurance policy rather than a core holding and should not make up a significant portion of a client’s portfolio, due to its inability to deliver significant long-term real returns.”