In the past half decade, gold prices were fueled by negative rates. Now gold is driven by geopolitical risks, efforts at gold-backed trade and local prices.
Not long ago, the conventional wisdom was that the recovery of the US economy would support rate hikes and thus a stronger US dollar, which would pave way for gold’s further decline.
It was conventional wisdom at its best: persuasive but flawed. US recovery does not mean a return to the pre-2008 world, but secular stagnation across major advanced economies. Consequently, as I have argued since the early 2010s, the Fed’s rate hikes will be lower and have longer intervals than anticipated.
While the Fed has begun its tightening trajectory, central banks in Europe and Japan continue to maintain quantitative easing and record-low interest rates. Historically, periods of low rates — not to speak of negative rates — tend to correlate with gold returns significantly higher than their long-term average.
But is the implication that the return of rate hikes will mitigate gold gains? No, not anymore.
After months of gains last year, gold fell to US$1,140 in December. But the past quarter has witnessed a wave of gains as gold recently rallied to a five-month high of US$1,290.
There are new drivers behind gold as tensions rise in Syria and elsewhere. With increasing global jitters, investors are seeking out traditional havens from geopolitical risks.
More is coming. While Marine Le Pen may not win the second round of the French election in May, the bitter political struggle has increased short-term uncertainty in Europe, which will soon also witness the German election and Italy’s parliamentary turmoil.
While Trump’s campaign priority was to reset US relations with Russia, ties are now worse than before.
As investors escape to these havens, Treasuries are no longer the obvious choice as central banks have turned the bond market into a bubble.
Instead, gold, under-represented in many portfolios and under-valued in current prices, seems a safer bet.
The role of gold may also be shifting in world trade. In March, the Russian central bank opened its first overseas office in Beijing to foster Sino-Russian monetary cooperation.
The move came as Moscow prepares to issue its first federal loan bonds denominated in yuan, while Russia — the world’s largest gold producer after China, Japan and the US — may become a major supplier to China.
All of these scenarios contribute to speculation about efforts to shift to a gold-backed standard of trade, bypassing the US dollar.
Gold is still priced in dollars and thus assessed in relation to the dollar. But about 90 percent of physical demand for gold comes from outside the US. So, for all practical purposes, most investors already price gold in local currency — particularly the yuan and the Indian rupee.
For non-dollar buyers of gold in emerging economies, it is the local price that counts.
In 2016, as the dollar strengthened, gold’s return in euro, sterling, the rupee and yuan was higher than in dollars. Indicators that track the price of gold from a non-dollar perspective, show its return has been on average 2.3 percent higher per year than the return of gold in dollars for the past decade, driven by periods of dollar strength.
The simple conclusion is that, viewing gold from an exclusive dollar perspective effectively ignores the benefits that global investors — particularly those in emerging economies — derive from adding gold to their portfolio.
Dan Steinbock is the founder of Difference Group and has served as research director of international business at the India, China and America Institute (US).