Gold’s spring rally was undoubtedly spectacular. In just a few weeks, the dollar-denominated gold price rose by nearly 20%, and was up 21.7% in the first half of the year alone. In euro terms, the price of gold rose by 16.4% in the first six months of the year.
It is noteworthy that all this is happening in an environment where, according to past patterns, gold prices should be falling. The breakdown in the correlation between gold prices and real interest rates raises many questions. In the old paradigm, it would have been unthinkable for gold prices to strengthen during a period of sharply rising real interest rates. Gold and its investors are now entering uncharted territory.
Traditional connections are breaking down
In addition to the highly negative correlation between gold prices and U.S. real interest rates, the once strong link between Western investor demand and gold prices has also disappeared in recent quarters. Given gold's record performance, people would have expected record inflows into gold ETFs, but the opposite has happened.
From April 2022 to June 2024, net outflows of physical gold from gold ETFs reached almost 780 tons. The old gold model shows that given the decline in ETF holdings, the gold price should be around $1,700. Therefore, an important element of the new gold model is that Western financial investors are no longer marginal buyers or sellers of gold, and strong demand from central banks and private Asian investors is the main reason why gold prices are still booming in an environment of rising real interest rates.
Reducing gold ETF holdings when real interest rates rise is undoubtedly a rational decision for Western actors, provided that they assume that:
1. They are not exposed to increased counterparty risk and therefore do not need default-free assets;
2. Real interest rates will remain positive in the future and there will be no second wave of inflation;
3. If they underweight gold and overweight traditional asset classes like stocks and bonds or even real estate, they will face an opportunity cost.
Marginal participants in the gold market are shifting from West to East
The East is becoming increasingly important as the West’s share of global GDP continues to decline due to slowing growth and aging populations.
In addition, many Asian countries have a historical relationship with gold. In 2023, the global demand for gold jewelry will total 2,092 tons. Among them, China accounts for 630 tons, India accounts for 562 tons, and the Middle East accounts for 171 tons. The sum of these three accounts for almost two-thirds of the total demand. Of the nearly 1,200 tons of gold bars and coins demand in 2023, almost half will go to China (279 tons), India (185 tons) and the Middle East (114 tons).
Central bank demand for gold is growing in importance
After the Russian-Ukrainian conflict broke out and Russia's currency reserves were frozen, the central bank's demand for gold accelerated significantly. As a result, central bank demand for gold reached a new record of 1,000 tons in 2022 and almost reached this level in 2023. The first quarter of 2024 was the largest first quarter for central bank gold purchases on record.
As a result, central bank demand for gold has increased significantly: from 2011 to 2021, gold's share of central bank foreign exchange reserves hovered around 10%, while in 2022 and 2023 this figure reached almost 25%.
The profound distortions caused by the sanctions on Russia’s monetary reserves are likely to keep central bank demand for gold high for some time, as evidenced by the World Gold Council’s recently released World Gold Survey 2024.
The survey showed that 70 central banks believe their gold reserves will continue to grow. Geopolitical instability is the third most important reason for central banks to make investment decisions, and geopolitical instability will undoubtedly be with us for some time.
The debt bomb is ticking
The world is entering a new era, and this is particularly evident in the countries with the highest total debt.
Japan ranks in the ignominious first place with a debt ratio of over 400%. The sharp depreciation of the yen, which has depreciated by 12.3% in the first half of 2024 and 32.6% in the past five years, and even depreciated by about 50% compared with its almost historical high in 2012, is a symptom of Japan's increasingly unbalanced debt.
France ranks second in the world and first in Europe with a debt ratio of 330%, becoming a bigger problem than Italy.
In addition to continued highly accommodative fiscal policy, the United States has an increasingly complex domestic political situation, including a poor performance in the first televised debate between Biden and his predecessor and rival Trump four months before the presidential election, which will also make it more difficult to solve the US debt problem, especially since Trump is leading in the polls and once called himself the "debt king" a few years ago. Therefore, the next major debt crisis may affect some major developed countries.
As a result, we may be witnessing a fundamental shift. Old certainties are fading and established strategies are failing. The willingness to question established mindsets and forge new paths often requires courage, but for those who can recognize the signs of the times and dare to change, embracing gold’s “new script” could open the door to growth and stability for the asset.
In principle, the new gold paradigm suggests that investors’ portfolios should have a higher allocation to alternative asset classes to adapt to changes in the investment environment.
The article is forwarded from: Jinshi Data