In recent years, the world has undergone significant changes that have shaped its current state. The pandemic caused by COVID-19 has been the most severe since 1918 and the third most significant in world history. We’ve experienced a global supply chain breakdown. The pandemic caused a shortage of goods, raw materials, and labor, leading to delays and disruptions in production, trade, and distribution. This shortage, coupled with inflation, which has been the worst since the early 1980s, has resulted in price increases and a rise in the cost of living for many.
Meanwhile, Europe is currently facing its worst war since the end of World War II. The conflict in Ukraine has resulted in a financial and economic war between major players like the U.S., the U.K., the EU, and Russia. This war has led to extreme financial sanctions, including seizing the central bank reserves of one of the world's largest economies, causing further supply chain disruptions.
China, the world's second-largest economy, has also faced its own unique set of challenges. The country locked down 50 million people in Shanghai and Beijing for months in a misguided attempt to suppress COVID-19. However, they eventually learned that the virus spreads regardless of lockdowns. The ongoing tensions in the Taiwan Strait have also heightened the risk of conflict, with the potential for a Chinese invasion or blockade of Taiwan.
So, if gold is the ultimate safe haven, and the world has been dangerously unsafe, then why has the price of gold not skyrocketed yet?
The current price of gold is approximately $2,030 per ounce, having gained just over $200 in the last month. It is interesting to note that the current price of gold is still lower than its all-time high of $2,069, which was recorded on Aug. 6, 2020. This indicates that the price of gold has not risen in line with the perceived level of risk in the world.
Now back to the original question. With the ongoing war, banks failing all over the place, inflation, and shortages all around, why is gold not surging past $3000 per ounce?
The current supply and demand conditions suggest that gold prices may increase in the near future. Despite global gold production remaining relatively constant over the past seven years, central banks have significantly increased their official holdings during the same period.
Over the last thirteen years, China has officially added over 1,400 metric tonnes of gold to its reserves. Unofficially, this number is believed to be much higher. Similarly, Russia has acquired over 1,500 metric tonnes of gold during the same period.
Other countries that have increased their gold holdings include Poland, Turkey, Iran, Kazakhstan, Japan, Vietnam, and Mexico. Even central banks in the Visegrad Group, consisting of the Czech Republic, Hungary, Poland, and Slovakia, have been buying gold.
Individual investors in the United States appear to be largely indifferent towards gold as a monetary asset, despite the increasing interest from central banks. Central banks, being the most knowledgeable about the real condition of the global monetary system, have been purchasing large quantities of gold with hard currency such as dollars or euros.
Given this trend, it is unclear why retail investors are not following suit. It should be noted, however, that central bank holdings only represent about 17.5% of the total above-ground gold, with much of the demand coming from bullion investors and jewelry buyers who see gold as a form of wearable wealth.
Interest rates have played a significant role in the direction of gold prices over the past three years, with many movements in gold prices being linked to interest rate changes. Although the correlation between the two is not perfect, it is still strong.
For instance, the surge in gold prices towards the end of 2020 was linked to a decline in interest rates on the 10-year U.S. Treasury note from 1.930% on December 19, 2019 to 0.508% on July 31, 2020. Conversely, the drop in gold prices after February 2021 was related to a rise in interest rates on the same note from 1.039% on January 2, 2021 to 3.130% on May 2, 2022, which currently stands at 3.44%.
However, it is anticipated that interest rates on the 10-year Treasury note will once again decrease as global growth weakens, which is promising news for gold investors. Although short-term rates have risen due to the Federal Reserve's policies, long-term rates are expected to drop as investors anticipate a recession caused by the Fed, resulting in higher gold prices.
Despite favorable market supply/demand conditions and a supportive interest rate environment, neither has been enough to push gold sustainably beyond $2,000.
What’s the problem?
The primary obstacle for gold and why it has struggled in the last three years is due to the strength of the dollar. This is because the value of gold in dollars is inversely proportional to the strength of the dollar. Therefore, when the dollar weakens, the dollar price of gold increases and vice versa.
Although it may seem counterintuitive, the dollar has remained strong despite the rising inflation levels. The reason for this is the demand for dollar-denominated collateral, mainly in the form of U.S. Treasury bills, to support leverage on bank balance sheets and hedge fund derivatives positions. As a result, banks require dollars to pay for the Treasury bills, thereby increasing demand for the currency.
The scramble for collateral also reflects concerns of a banking crisis after SVB's collapse, weak economic growth, fears of default, and decreasing creditworthiness of borrowers. These factors have increased the fear of a global liquidity crisis. Although it is not yet upon us, we are inching closer without any indication of relief in sight.
As global growth slows down, a financial panic will likely emerge, and the dollar may no longer be considered a safe haven currency. This may lead to a shift in demand towards gold, especially considering the aggressive use of sanctions by the U.S. and the reluctance of major economies such as China, Russia, Turkey, and India to rely on the U.S. dollar system.
Therefore, investors should consider the current prices of gold as an opportunity and possibly the last chance to acquire gold at these prices before the real safe haven race begins.
Even at prices above $2,000, gold is so cheap right now, it’s basically a steal.
Stay alert, stay informed.
WaveCap
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