What’s got into gold?

Key takeaways

• Successive gold price records – as high as USD 2,195/oz – in recent weeks look driven by speculative flows. Our fair value model sees gold prices around USD 2,070/oz given the current macroeconomic backdrop
• Demand from central banks diversifying their reserves has offset outflows from passive investments and become another structural factor, along with real interest rates, for gold prices
• The US dollar, traditionally one element driving gold prices, now looks like a neutral factor
• We estimate that gold may reach USD 2,250/oz a year from now on the back of a Fed pivot and resilient demand from central banks. We maintain our strategic exposure in portfolios. 

Gold prices repeatedly set record highs in the first weeks of March. Why? In the past, three factors explained gold market moves: real (adjusted for inflation) interest rates, physical demand for bullion and moves in the US dollar. What has changed to drive prices so high, and what’s next for the precious metal?

In the first two weeks of March gold prices surged through a series of records, gaining 5.5% and hitting a high of USD 2,195 per ounce. This sharp jump surprised investors and seemed disconnected from rate and currency markets. Historically, gold prices have risen on falling real interest rates, and vice versa; the recent extreme rise in gold prices cannot be explained so easily. Flows of exchange traded funds (ETFs) backed by physical gold cannot account for recent moves: ETFs continued to report outflows in March despite high-flying gold prices.

The main factor fuelling gold prices in our view is inflows from systematic, momentum-driven financial investors. Weekly futures contract reports show that money managers rushed to the gold market, driving net speculative positions in the market close to highs seen in 2023. That reflects their bets on an earlier-than-consensus first cut by the Federal Reserve (Fed), based on weaker-than-expected manufacturing data in the US released at the start of March. However, we see that gold prices paused their rally after the release of February US inflation data, and markets barely adjusted their rate cut expectations.

Therefore, the scale and speed of gold price moves in March in our view is more flow-driven and likely overdone. Our fair value model estimates the price of gold should be around USD 2,070/oz, compared with today’s USD 2,155/oz. Nevertheless, this jump illustrates the power of investment flows while confirming our positive outlook for the metal. To be sustainable, higher prices need more fundamental support. That, we think, is already evident from real rates and physical demand.

Central bank demand

If we look at gold’s performance over the past two years, it is hard to ignore that central bank demand has become another factor affecting gold prices, in addition to the traditional drivers of US real rates and the dollar. Since 2022, central bank demand has completely offset outflows from passive investors.

Central banks have been reversing their net selling trend that started with the collapse of the Bretton Woods system and lasted until the Great Financial Crisis. After the Russia-Ukraine war, they have accelerated their acquisition of bullion. A primary reason for this is to diversify foreign currency reserves in a changed geopolitical landscape. After Western governments imposed sanctions on Russia and froze dollar assets, emerging market central banks have worked to ‘de-dollarise’ their reserves and replaced such assets with gold. The People’s Bank of China is leading this trend and has been adding gold to its reserves for the last 16 months, making it the world’s largest buyer in 2023. Other BRICS¹ countries and wealthy emerging economies such as the Gulf states and Singapore have also emerged as large gold purchasers.

This trend looks likely to continue according to a survey by the World Gold Council. This found that 62% of central banks plan to increase their share of gold in total reserves, compared with 46% in 2022. Since gold reserves only account for 5% of central banks’ total reserves, there is ample potential strategic demand in the coming years.