Is gold really expensive already?

Contrasts in the gold market are currently more visible than ever before. Just recently, historical highs were recorded at just over $2,430 per ounce, and a few days later, the largest daily loss in many years was recorded. Furthermore, gold remains only 5% away from historical highs, with US yields exceeding 4.6% and ETF funds holding the smallest amount of gold since September 2019. With such extremes, does the price of gold above $2,300 per ounce not seem too high? Or perhaps the reversal of some conditions could fulfil some financial institution forecasts of precious metal reaching $3,000 per ounce.

Central banks and individual investors are still buying gold

Analysing the commodity markets, we almost always look at the supply and demand relationship. In the case of gold, we have been observing excess supply for years, but in this case, it is not as much of a problem as it is for oil or industrial metals, which are not assets considered to be storer of value. The largest part of global demand for gold comes from the jewellery sector, whose share in total demand often exceeds 50%. However, it is worth noting that this demand is rather stable, or its dynamic changes are not too significant from year to year. We observe significantly greater changes in investment demand for physical gold and from central banks. Recently, the share of these two groups has been increasing to almost 50%, although not long ago it was below 50%. If we add ETF funds, which also invest in physical gold, their share at one point approached 60%. This happened in 2020 when the tremendous liquidity in the market caused by the actions of central banks and governments during the pandemic led to a buying frenzy in many markets. Since then, investors have been withdrawing their funds from ETFs, turning more towards the stock market or even recently towards the cryptocurrency market. Could interest rate cuts in the US change this trend?

The Fed remains hawkish, but still wants to lower rates

Gold has remained at high levels over the past few dozen months, even despite the significant rise in interest rates in the US and most of the world's major economies. This situation showed that gold holds its value at times of great uncertainty regarding the continued inflation fight. Nevertheless, speculations about rate cuts, which emerged at the end of last year, led to gold permanently settling above $2,000 per ounce. Furthermore, rate cuts, or rather the expectation of cuts in previous years, caused increases in the price of gold. Therefore, it might seem that the prolonged period of waiting for cuts favours further increases in gold prices. However, in this case, a coincidence occurred in the form of a series of geopolitical conflicts around the world, which, along with growing demand for gold, further fuelled its rise. If tension persists and interest rates are lowered, it may even more strongly stimulate the desire to buy gold, also from ETF funds, which constitute the final piece in building a multi-year bull market in precious metals.

Does geopolitics matter for gold?

The war between Russia and Ukraine led to an increase in gold prices above $2,000 per ounce. Nevertheless, since March 2022, the behavior of the dollar and yields has decidedly been the most important factor for the direction of gold price moves. The situation changed in October of last year when the conflict between Israel and Hamas began, which ignited several other hotspots in the Middle East. Generally, geopolitics has rather limited long-term influence on gold, but if it goes hand in hand with an increase in demand for gold from hedge funds, then the situation takes on a completely different shape. Funds have significantly increased the number of long positions in futures contracts, although their quantity still remains far from the extremely high levels we saw in 2020. This shows that there may potentially be room for further increases, especially if we look at what is happening in China.

China has gone crazy for gold

China has long been one of the largest consumers of gold, trying to surpass India in this regard. At this moment, when the whole world is trying to move away from the US dollar and increase its reserve diversification, it is heading towards gold. The People's Bank of China has been buying gold continuously for 17 months. China is currently in 6th place in terms of the amount of gold held, but it is not far from surpassing countries like Russia, France, or Italy. Furthermore, there is often speculation that the official gold purchases by the PBOC are only a fraction of China's real purchases.

Madness also takes place in the Chinese futures market, where the number of long positions in gold has exceeded 300,000 contracts and reached the highest value in history, equivalent to over 300 tons of gold. This is a doubling of long positions compared to the beginning of 2023. It may also be related to the ban on cryptocurrency trading and the general trend of seeking safe havens from the uncertainty related to still high inflation, the geopolitical situation in the Middle East, tensions between the US and China, or the upcoming US presidential elections.

What is the risk for gold? 

Certainly, the risk for the price of gold is a complete de-escalation of the geopolitical situation worldwide, which would reduce demand for safe haven assets. On the other hand, stock markets remain very overbought, so the risk in the market remains very high. The second factor that threatens gold and other metals is the potential return of high inflation, which would force central banks to return to raising interest rates. Of course, it can be argued that gold seems overvalued after reaching historical highs, but looking at the metal in relation to the prices of other assets such as copper, oil, the S&P 500, or in relation to the still huge central bank balance sheets, it seems that gold still may have more upside ahead. The level of $2,500 per ounce does not seem distant, and more and more financial institutions present forecasts in which $3,000 seems to be the base scenario even for 2024. Of course, it should be remembered that any investment in gold should only constitute a part of the entire investment portfolio, and the investment itself should be treated in a long-term context. Looking at 5- or 10-year investment periods in the last 30 years, there were very few situations where the return on such an investment was negative.