When it comes to investing, gold may be the antithesis of artificial intelligence (AI). The precious metal has acted as a store of value for thousands of years with zero technological innovation — gold is discovered, not developed. Gold is also a real tangible asset and can act as a potential hedge against inflation or a safe haven during times of crisis. Given these properties and the backdrop of a risk-on-record-setting equity market, many investors are wondering what is behind the paradoxical price action of gold’s rally to new highs and how the yellow metal has matched the momentum in AI stocks over the last several months (gold and the equal-weight Magnificent Seven Index are both up around 20% since March). Herein we discuss the key drivers of gold and why this rally is no flash in the pan.
After consolidating sideways for several years, spot gold prices finally reached record highs in March. The rally continued into the summer months as expectations for a monetary policy pivot from the Federal Reserve (Fed) firmed. Interest rates and the dollar subsequently declined as the market began to price in higher probabilities for rate cuts. A rally was an expected response for gold, as lower U.S. interest rates and a weaker dollar increased the appeal of non-yielding bullion.
Perhaps more surprising is the lack of demand for gold exchange-traded funds (ETFs). Until recently, ETF holdings of gold had inexplicably decoupled from the precious metal over the last two years. However, with gold breaking out to new highs and creating a lot of headlines along the way, fear of missing out appears to be kicking in. Buyers have returned to chase this rally as gold ETF holdings recently reported seven straight weeks of positive inflows, marking the longest inflow streak since March 2022. History suggests this trend could continue as peaks in gold ETF holdings tend to occur after peaks in gold prices.
A weaker dollar and declining interest rates have played leading roles in gold’s rally to record highs. However, in recent years, central banks have increasingly played a supporting role. According to the World Gold Council, global central banks purchased record levels of gold in 2022, followed by near-record-level buying in 2023. More recently, global central banks bought 183 tons of gold in the second quarter, marking a 6% increase compared to last year. Rising demand has been driven by foreign central banks diversifying away from dollar reserves, partially due to worries about escalating U.S. deficits, and perhaps more significantly, concerns over the potential seizure of reserve assets by the U.S. government — as Russia witnessed after the 2022 invasion of Ukraine.
Central banks are not the only ones buying gold. According to the Commodity Futures Trading Commission (CFTC), managed money long positions (typically speculators, hedge funds) in gold recently reached their highest level since March 2020. Over-the-counter demand for gold has also jumped higher. India, the world’s second-largest consumer of gold jewelry, cut the import tax on gold to 6% from 15% in July. Imports of gold tripled the following month as Indian buyers ramped up purchases ahead of Diwali and wedding season this fall, when gold is often a traditional gift.
Rate cuts generally imply lower yields and a potentially weaker dollar — a recipe for stronger gold prices as other income-generating safe haven assets become less competitive and the commodity becomes cheaper to purchase. And while inflation is falling (at least for now), potentially reducing the allure of gold as an inflation hedge, the direction of interest rates, central bank demand, and the geopolitical climate tend to have more of an impact on the yellow metal.
Of course, the Fed has a significant impact on interest rates, and with the pivot to rate cuts officially underway, we looked at how gold performed after the Fed started cutting rates. Based on the last nine major rate-cutting cycles since the 1970s, gold has generated an average 12-month gain of 3.7% following the first rate cut. The peak in gold performance has historically been around the six-month window, where average gains reached 10.8%, suggesting the current upside momentum could continue at least into the first quarter of next year.
Gold has climbed to new highs amid a backdrop of building broad-based demand, falling yields, a weaker dollar, and elevated geopolitical risk. Momentum could continue as it has historically posted strong six-month returns after rate-cutting cycles begin.
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