With the blessing of "conflict" and "central bank", gold's "safe haven era" has begun?

This year, gold is undoubtedly the best safe-haven asset.

The international gold price, in the midst of the Palestinian-Israeli conflict, soared to $2,000 per ounce.

The domestic gold price has triggered the younger generation to "awaken the bloodline" and compete for allocation, and the consumption of gold bars and coins has soared by 15.98%.

Originally, in the ups and downs of gold prices, the real interest rate of US bonds was the most important determinant of gold prices.

However, since 2022, central banks have gone on a gold buying spree to break the relationship between gold and real interest rates, and fears of geopolitical conflicts have also added fuel to the fire in gold prices.

With the blessing of "conflict" and "central bank", has gold opened a "safe haven era"?

1. The grand narrative of gold - geopolitical conflict

The so-called "when the cannon goes off, the gold is ten thousand taels". Since 2022, due to the impact of geopolitical conflicts such as the Russia-Ukraine conflict and the Palestinian-Israeli conflict, the safe-haven demand for gold has risen, resulting in a significant geopolitical risk premium in gold prices.

So how much "gold price" can the grand narrative of geopolitical conflict hold up?

By summarizing the performance of gold after major geopolitical conflicts since the 80s of the 20th century, Lightell found that the impact of geopolitical conflicts on gold prices was shorter than imagined.

● On the day of the conflict or the next trading day, the price of gold rises and falls by half.

● The gold price averages its highest price on the 15th trading day of the conflict.

● Gold rose an average of about 5.85% over 30 trading days.

● After 50 trading days, the impact of the conflict on gold prices began to fade.

Note: The gold price is based on the closing price of the COMEX Gold continuous contract.

Taking the Russia-Ukraine conflict last year as an example, gold rebounded driven by safe-haven demand, but eventually reversed as the Fed started its interest rate hike cycle and real interest rates came out of negative territory.

In the recent Palestinian-Israeli conflict, gold's performance has been stronger than the average response to historical conflicts, close to the Gulf War and 911. (See red line below). One difference is that the gold price has adjusted by almost 10% in the second to third quarters before the conflict.

Summarizing these historical events, we can see that the safe-haven premium of geopolitical conflicts on gold is mainly reflected in:

1. Whether the event has impacted the US dollar system (such as energy supply disruption and US impact); 2. The extent and duration of the event exceeding expectations; 3. Whether the event led to a sustained rise in inflationary pressures.

Although the current geopolitical conflict has led to higher oil prices, the impact of Israel and Palestine on the oil market is limited, and crude oil prices may rise in the short term, but I am afraid that an oil crisis is unlikely.

Therefore, if there are no more macro factors to promote, the rise in gold prices due to geopolitical conflicts is a short-term phenomenon.

Second, the big buyer of gold - the central bank buys gold

In addition, in recent years, the United States has abused the dollar's status as a reserve currency, weakening the dollar's status as a traditional reserve currency.

As a result, since 2010, global central banks have entered the era of annual net gold purchases. This is especially true for emerging market countries, which are suffering greatly from the dollar. Since the global financial crisis, central banks have bought 6,815t between 2010 and 2022.

After the conflict between Russia and Ukraine, the sanctions imposed on Russia by the United States and Europe and other countries have impacted the safe-haven attribute of using safe-haven currencies as reserve assets. The need to diversify foreign exchange reserves has surged again, further increasing gold reserves.

According to the World Gold Council, central bank purchases rose sharply in 2022, reaching 1,082t for the year, up 631t y-o-y, significantly outpacing the increase in global gold demand in 2022 (42t).

Central bank gold demand also rose sharply to 23% of global gold demand from 10% in 2010-2021, with official gold reserves exceeding 35,000t, almost one-fifth of gold above-ground stocks.

From the perspective of pricing factors in gold prices, it is mainly affected by inflation expectations, real interest rates, safe-haven demand, and the dollar index.

According to research by Huatai Securities, from 1970 to 2000, inflation expectations and safe-haven demand were the main determinants of gold prices. However, after 2000, as gold's financial attributes strengthened, real interest rates became the most important determinant of gold prices.

Gold can be considered a long-term, risk-free asset similar to Treasuries. But unlike Treasuries, gold is a zero-dividend asset (no interest), so the opportunity cost of holding gold is the real interest rate. So usually there is a clear negative correlation between rising real interest rates and falling gold prices.

However, the central bank's significant increase in gold holdings since last year has become a very important reason for gold prices to deviate from the real interest rate of US bonds.

According to the latest data from the World Gold Council, global central bank gold demand will remain strong in 2023. Gold purchases in the first half of the year reached a record high of 387 tonnes, and at this rate, the annual gold purchase demand may exceed 750 tonnes. Although it is not as high as last year, it is also well above the average of net central bank purchases in the previous decade.

If the geopolitical conflict has pushed gold prices up in the short term, then the central bank's gold purchase demand may be structurally higher than before the epidemic, providing some support for gold prices in the medium term.

3. The opening of the "hedging era" of gold?

However, in the second quarter of last year and this year, when the real interest rate of US bonds rose rapidly, even with the blessing of geopolitical conflicts and central banks, gold prices still suffered significant downward pressure, with maximum declines of 20% and 10% respectively.

Therefore, if we want to use gold as part of our asset allocation, we ultimately need to focus on the macro-cyclical factors that drive the gold price, such as real interest rates, economic growth, inflation, monetary policy, and the US dollar.

Gold, which is essentially a zero-coupon asset, is still the real interest rate of U.S. bonds, and even if the short-term correlation weakens in the short term, it will still not be able to "part ways" in the long run.

At present, as real interest rates remain high and may even continue to climb, gold, as a zero-dividend asset, will continue to be under pressure. SPDR's gold holdings, the world's largest long gold financial asset, have fallen to 860 tonnes, a four-year low.

Of course, such a high real interest rate may not be sustained for long, and if the US starts cutting interest rates in 2024, will this further trend support for gold prices?

The key question is whether gold's premium due to safe-haven demand will gradually disappear.

In other words, will we enter a more "risk-off era" or will we revert to a "risk era"?

This issue is controversial even within policy agencies and financial institutions.

On the one hand, the biggest risk to the global economy after the pandemic, inflation, is under control. On the other hand, the market remains skeptical about the extent of the recession and the risks that a rapid tightening could cause.

However, judging from the current situation, the United States has been shouting for a recession since the beginning of the year, and now the growth is still accelerating. US real GDP rose sharply and better than expected at an annualized rate of 4.9% in the third quarter. Consumer spending on goods in the U.S. has remained surprisingly strong, and new home sales have also risen more than expected.

This shows that the growth momentum of the U.S. economy, which is the locomotive, is still very strong. Even if the market has always expected a slowdown in the marginal growth of demand in the future, the slowdown is still much better than expected, supported by the job market and consumption.

China has stepped up stability, Europe has paused interest rate hikes, and Japan has withdrawn in an orderly manner. At the same time, under the increase in easing policies, China has gradually entered the end of destocking, and the economy is likely to bottom. The European Central Bank (ECB) has pressed the pause button on rate hikes or may enter a milder recession, and the easing of inflation is also leading to a slight pickup in economic activity. The Japanese economy has achieved three quarters of quarter-on-quarter growth, and the YCC policy is also being further phased out.

Looking at the growth prospects of the top five economies, the evidence does not seem to be sufficient to enter a new era of more risk aversion.

Of course, no one knows whether the conflict in the Middle East will escalate, whether there will be new geopolitical conflicts, or if a new Silicon Valley Bank affair will erupt.

Aside from these unexpected factors, the current gold is not cheap, and some brokerage research reports have calculated that its relative long-term pricing model price has been overestimated by about 33%.

Is $2,000 an ounce a high point for gold or a new starting point for gold? Is it the era of risk aversion or the age of risk?

I'm afraid there are a thousand Hamlets in the eyes of a thousand people.

Light narrated by Lightell

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