According a mid-year outlook report released by the World Gold Council (WGC) on July 2, gold has performed well so far this year, with a 12% rise in returns year-to-date and outpacing most major asset classes.
Gold has so far benefitted from continued central bank buying, Asian investment flows, resilient consumer demand, and a steady drumbeat of geopolitical uncertainty. However, the key question in investors’ minds going forward is whether gold’s momentum can continue or if it’s running out of steam, the WGC muses.
With a few exceptions, the global economy is showing wavering growth indicators – eager for rate cuts – amid lower but still uncomfortable inflation, and the market’s outlook is not too dissimilar, the WGC says.
“Our analysis suggests that the gold price today broadly reflects consensus expectations. However, things rarely go according to plan and the global economy, as well as gold, seem to be waiting for a catalyst.
For gold, we believe the catalyst could come from falling rates in developed markets, that attract Western investment flows, as well as continued support from global investors looking to hedge bubbling risks amid a complacent equity market and persistent geopolitical tensions,” the WGC says.
However, the organisation maintains that gold’s outlook is not without risks, and that a sizeable drop in central bank demand or widespread profit-taking from Asian investors could curtail its performance.
As it stands, however, global investors continue to benefit from gold’s role in robust asset allocation strategies, the WGC believes.
Gold broke record highs multiple times between mid-March and mid-May, with gold trading above $2 300/oz for most of the second quarter. It has also provided double-digit returns across multiple currencies.
This has occurred despite high interest rates globally, barring a few exceptions, and a strong US dollar – a combination that is often seen as a hostile environment for gold.
“The relationship between gold, real interest rates and the US dollar is not ‘broken’, as some market participants may think. In fact, this relationship has likely prevented gold from rising further. It is simply that, in the current environment, these factors have been offset by others that are more dominant,” the WGC explains.
The WGC posits that the reason for gold’s record-breaking performance to date this year comes from continued purchases by central banks, strong Asian investment and resilient global retail consumer demand.
SECOND-HALF OUTLOOK
The global economy and financial markets are in a transitional period, the WGC says.
“Bond yields have moved generally sideways as Western central banks have kept policy rates on hold. But pressure is mounting on policymakers as they balance lower but stubborn inflation and signs of cooling labour markets,” the organisation says.
The WGC highlights, as an example, the sooner-than expected rate cut by the European Central Bank (ECB), while the Bank of England and US Federal Reserve (Fed) have so far remain unchanged.
“Meanwhile, India remains one of the economic bright spots, and China will likely continue to find alternative measures to invigorate growth,” the WGC points out.
Analysis based on the WGC’s Qaurum gold valuation tool, along with the council’s gold valuation framework suggests that the current gold price broadly captures consensus expectations for the second half in relation to economic growth, interest rates and inflation.
The WGC believes this implies that gold may continue to move in a similar range to what has been seen in recent months.
“In other words, after gaining good momentum in the first half of the year, current market trends indicate a rangebound performance from its current levels during the second half. It’s not the first time we have described a similar anticipated outcome for gold,” the WGC says.
At face value, a sideways move does not seem very exciting, the organisation notes, even though it encapsulates two important insights.
“First, we are naturally using ‘expected’ rather than ‘observed’ values for each of the drivers; in this context, a rangebound return suggests that the gold market is fairly efficient and broadly reflects the available market information.
Second, given that gold is already up by more than 10% and consensus suggests a similar result for the full year, it reiterates that gold – supported by contributions from other sectors – can perform well even when rates remain as expected,” the WGC explains.
Given the inherent complexity in forecasting economic and financial variables, the WGC says it is important to understand the conditions that could cause a divergence from the current view.
“For gold, Western investors have been a missing part of the puzzle. While investors have been active – as denoted by high market volumes – retail investment demand has been low and gold exchange-traded funds (ETFs) have seen net outflows year-to-date.
“Gold’s strong performance, despite the absence of strong Western flows, suggests that, unlike previous periods when gold broke record highs, the market is still not saturated and could see another leg up,” the WGC says.
Demand from this segment of the market could be triggered from three key sources: interest rates, recession risks and geopolitics, the council points out.
Since the interest rate cut by the ECB in May, European gold ETFs have experienced inflows. A continuation of this trend would provide further support.
“While there’s already a 25 basis point cut by the Fed priced-in by the market for later in the year, the actual policy decision would bring reassurance to investors about the direction of rates going forward, thus fostering sustained inflows. On the flip side, of course, higher-for-longer may deter some gold investors from entering the market,” the WGC explains.
While a recession remains a low probability in the immediate term, the global economy continues to underperform and, with inflation above target, central banks are not ready to cut rates more aggressively just yet, the WGC points out.
The council also notes what appears to be some complacency in financial markets.
“Global stocks are doing well overall with US stocks – or a subset thereof – leading the pack. And volatility is near 30-year lows. Yet, historically, there’s a strong relationship between the strength of manufacturing and company earnings and, at present, these are showing signs of slowing,” the WGC says.
In terms of geopolitics, while some believe the current unease is simply “the new normal”, geopolitical risk has been on the rise in recent years and seems unlikely to abate anytime soon.
The ongoing political polarisation, armed conflicts and erosion of globalisation in favour of nationalism and select alliances appear to be fuelling economic instability.
“Geopolitical risk is particularly difficult to predict and may come from where it’s least expected. What is true, however, is that gold reacts to geopolitics, adding 2.5% for every 100-points the geopolitical risk index moves up. And while part of this effect can be transient, it could also be a trigger for deteriorating financial conditions, which may have a more lasting effect,” the WGC explains.
The council says this, combined with notable sales, has raised questions as to whether demand from the official sector may lose momentum.
However, the council still expects central bank demand to remain above trend this year – a view that is shared by Metals Focus in its most recent Gold Focus report.
While reported gross purchases may be lower than last year, gross sales have also decelerated, primarily owing to the absence of large-scale Turkish sales witnessed in early 2023.
“Given that central bank demand is often policy driven, timing is difficult to ascertain, but our recent central bank survey provides some reassurance: gold reserves managers believe they will retain their positive outlook towards gold,” the WGC says.
Insofar as Asian investors are concerned, the WGC believes they have been important contributors to gold’s recent performance, as evidenced through bar and coin demand, gold ETF flows and, anecdotally, in the over-the-counter market.
“In the past, Asian investors tended to buy on dips, but more recently, they have followed the trend. For example, we have seen meaningful assets under management growth in both Indian and Chinese gold ETFs and gold’s move up in early quarter two coincided with a spike in volumes in Shanghai futures,” the WGC says.
It adds that Chinese investor demand was partly supported by positive sentiment linked to central bank buying. Therefore, while the fundamentals of gold ownership remain in place, the WGC questions whether a pause by the People’s Bank of China may encourage profit-taking by more tactical investors.
All told, the WGC expects consumers will continue to be ‘price takers’ rather than ‘price makers’ in the short term. However, since gold jewellery and technology combined make up more than 40% of yearly demand, gold consumers play an important role in determining performance.
“They usually respond to two key factors: price and income. In this case, the sharp upward trend in the gold price has dampened demand in some markets such as India and China. But positive economic growth can counteract some of this effect.
“In addition, possible gold price stability can lure back consumers who often respond more negatively to volatility than the level of the gold price. This may be particularly relevant for India, where expectations of economic growth are higher than other regions and gold’s role as a store of value is well cemented,” the WGC posits.
The council’s analysis shows gold’s likely reaction to the underlying conditions behind market consensus, as well as alternative hypothetical scenarios.
“Gold may remain rangebound if current market expectations prevail. However, there’s a clear path for gold to outperform from here, likely fuelled by Western flows. Conversely, in the event that central bank demand drops drastically, rates remain high for longer and Asian investor sentiment flips, we could see a pullback in the second half,” the WGC says.
It notes that, overall, the extent of gold’s reaction upwards or downwards will be a function of the magnitude by which factors move.
“It is also important to note that each of these scenarios has implications for other asset classes. A robust asset allocation strategy must take into account not just market consensus but alternative views. And in that context, our analysis shows that gold plays a key role as a diversifier and source of liquidity, coupled with its positive long-term returns,” the WGC says.