The world has changed dramatically. We have had the worst pandemic since 1918, inflation has reached levels not seen since the early 1980s and Europe is experiencing its worst war since the end of the Second World War.
This war in Ukraine is accompanied by a financial and economic war between the United States, the United Kingdom, the European Union and Russia, which involves extreme financial sanctions. If gold is the ultimate safe haven for investors and the world is dangerously insecure, then the price of gold should skyrocket, right?
This is not the case. Today, gold is around $1,650 an ounce. This is more than 20% lower than the August 2020 all-time high and nearly 20% lower than the March 2022 midpoint high. In summary, gold is virtually at the same level today as there two years old. There have been ups and downs along the way, but always followed by a return to a persistent central trend that hasn’t moved much. With inflation, shortages and war raging and getting worse, why isn’t gold heading towards $3,000 and above?
Supply and demand conditions favor the rise in the price of gold. Global gold production has remained relatively constant for the past six years. While global output was stable, central banks increased their official holdings by 6%.
If central banks buy all the gold they can with hard currencies (dollars or euros), it is not clear what retail investors are waiting for.
Central banks are arguably the most informed players in the market and the steady increase in their gold holdings is significant.
Interest rates are also called upon to play a supporting role. Many of the directional movements in the price of gold over the past two years have been linked to changes in interest rates. The correlation is not perfect, but it is strong.
The rise in the price of gold at the end of 2020 was linked to a drop in interest rates (yield to maturity) on the 10-year US Treasury note. After falling to 2.722% at the end of May, these rates have rebounded to 3.324% so far. But I think the interest rates on the 10-year Treasury will go down further and continue to go down as global growth weakens.
This is good news for gold investors. Short-term rates are rising because of Fed policy, but long-term rates will fall because investors know the Fed is going to cause a recession. This corresponds to a rise in gold prices.
Although market supply and demand conditions are favorable for gold and the general interest rate environment is also favorable for gold, neither seems to have the power to push gold solidly past $2,000 in the near term. What is the problem ?
The main reason gold has struggled for the past two years is the strength of the dollar. What is driving the strength of the dollar and what could cause it to suddenly weaken and push gold prices into the stratosphere?
Dollar strength was boosted by demand for dollar-denominated collateral, primarily US Treasury bills, needed to back leverage in banks’ balance sheets and in hedge fund derivatives positions. These high quality guarantees are rare. The rush for collateral also reflects weak economic growth, fear of defaults, diminishing creditworthiness of borrowers and fears of a global liquidity crisis.
When weak growth turns into a global recession, another financial panic will loom on the horizon. At that point, the dollar itself may cease to be a safe haven, especially given the aggressive use of sanctions by the United States and the desire of major economies like China, Russia, Turkey and India to avoid the US dollar system if possible. The world will then turn to gold.
Investors should therefore view today’s prices as a gift and perhaps a last chance to acquire gold at these prices before the real safe-haven race begins.