Gold directed by Geopolitics!

Gold directed by Geopolitics!

Gold has clearly been given a lift from geopolitical stress. The war between Israel and Gaza has driven many to search for safe-haven assets and gold is a top contender. However, in the weeks leading to this, gold was getting flanked by the twin headwinds of an appreciating US Dollar and a bond sell-off. Gold held relatively well against such pressures but began to wilt, with the 50-day moving average (DMA) price falling below the 200-dma toward the end of September. That is what technical analysts call a “death-cross.”

However, despite its ominous name, that technical marker often signifies a new base. And true to that, gold has rebounded significantly, despite those bond and currency headwinds intensifying.
While we do not know how prolonged or severe the war will be, destabilisation in the Middle East serves as a reminder that geopolitical, financial, or economic stress can flare up at any moment and the best time to have an ‘insurance asset’ is before the event takes place. Gold is thus a valuable strategic asset.

While institutional demand for the metal has been muted for months, retail demand, especially in China and Turkey, is very strong. Central banks have also been very active in the gold markets this year and it is not expected that this trend will subside. Although demand in those pockets maybe seems like a reaction to localised concerns, it is believed that globally, institutional investors are likely to be increasingly concerned about global risks, geopolitical and financial, and seek more hedging tools.

We acknowledge that the fight for institutional investor attention is going to be difficult when defensive assets like US Treasuries are proving a yield (to maturity) of over 5% on the 2-year and close to 5% on the 10-year, compared to the zero-yielding asset that is gold. However, gold has
proven to be a very effective hedge against financial, geopolitical, and inflationary risks. While many thought that inflationary risks were under control a few weeks ago, a resurge in energy prices have led many to question that assumption (and once again should support the demand
for hedging instruments).

Gold is also viewed as a ‘safe-haven’ asset, meaning that during periods of economic uncertainty or heightened geopolitical risk, investors have historically turned to the precious metal for
protection, pushing its price up. As such, gold can act like a form of portfolio insurance and help provide downside protection during market turmoil.

Markets are expecting Federal Reserve (Fed) policy interest rates to be ‘higher for longer.’ In contrast to most rate cycles, when cuts start to come into play shortly after the last hike, bond markets are expecting a long pause at the top. That has driven 10-year nominal Treasury yields
to the highest level since 2007 and real yields to their highest since 2008. Gold, however, is holding its own, with the yellow metal continuing to defy the historic real yield-gold relationships.

Gold tends to perform strongly in recessions. The lag between an inversion and a recession can be long and usually more than a year. After hitting an all-time high in 2022, central bank demand for gold has maintained strong momentum. Between March and May 2023, Turkey’s central bank was selling gold into the domestic public markets to satisfy strong bar, coin, and jewellery demand following a temporary partial ban on gold bullion imports. That ban was put in place to soften the economic blow from the earthquake in February 2023. Since the import ban’s reversal, the Turkish central bank has resumed a strong buying programme and we have seen three consecutive months of buying (June – August 2023 purchases of 43 tonnes). However, because of the sales, cumulative Turkish official sector flows were negative (January – August 2023 sales of 70.5 tonnes). It is suspected that Turkey will be very active in replenishing its reserves. The People’s Bank of China has reported 10 consecutive months of gold purchases, amounting to 217 tonnes, over November 2022 – August 2023. Prior to this period, China had not reported any purchases since 2019.

Consensus is looking for inflation to continue declining (although remaining above central bank targets), the dollar to depreciate, and bond yields to fall from one of the most elevated levels seen since 2007. Without a consensus forecast on gold sentiment, we reduce speculative positioning to a conservative 75k, which is below the long-term average of 111k since 1995. The risk is clearly to the upside this year if a recession or financial dislocation materialises, or geopolitical tensions escalate.

Gold is a highly sought-after asset in times of economic, financial, and geopolitical stress, and these triggers could drive sentiment towards the metal even higher. In the consensus case scenario, gold reaches US$2,090/oz by Q3 2024, piercing through previous all-time nominal highs (US$2,061/oz on 7 August 2020). However, in real terms this does not reach an all-time high, which was reached in January 1980. In fact, it would be 40% below that level. And in real terms it is still 17% below the 2020 high.