Zhang Ming: Will the price of gold continue to rise?

Zhang Ming is Deputy Director of the Institute of Finance and Banking, Chinese Academy of Social Sciences, Deputy Director of the National Finance and Development Laboratory, and Director of the China Chief Economist Forum

Note: This article is the author's reply to the written interview with Tang Jun, a reporter from Caijing magazine, please be sure to indicate the source for reprinting.

Since November 2022, China's central bank has increased its holdings of gold by a cumulative 10.1 million ounces for 17 consecutive months. Vertically, this is the third time in the history of 2009 and 2015-2016 that the central bank has increased its holdings of gold by more than 10 million ounces in a row.

1. What do you think of the central bank's consideration of increasing its holdings of gold this time, and how is this different from the previous large-scale increases?

Zhang Ming: Since the outbreak of the new crown epidemic and the conflict between Russia and Ukraine, the global gold price has continued to rise, from about US$1,600 per ounce to about US$2,400, an increase of nearly 50%. Global sovereign investors collectively increased their holdings of gold, which was one of the main drivers of the current round of gold price increases. In the final analysis, this has to do with the "weaponization of the dollar" behavior of the United States after the Russia-Ukraine conflict. After Russia's invasion of Ukraine, the United States allies froze Russia's foreign exchange reserves, which means that the U.S. government announced a targeted default on U.S. Treasury bonds against Russian sovereign investors. The implications of this move are significant, as it means that US Treasuries, which are considered the safest assets in the existing international monetary system, are not as safe as investors think. Gold has regained the favor of sovereign investors as global sovereign investors' holdings of US Treasuries have declined significantly since Russia's invasion of Ukraine, and people have begun to look for alternative safe assets. If the previous rounds of the People's Bank of China's increase in gold holdings were more due to cyclical factors such as the depreciation of the US dollar exchange rate, then the current round of China's central bank holdings of gold is related to the consideration of geopolitical conflicts and the consideration of diversified and safe asset allocation.

2. What kind of signal does the central bank release to the outside world by continuously increasing its holdings of gold?

Zhang Ming: The global central banks have collectively continued to increase their holdings of gold, which shows that these central banks are worried that international geopolitical and economic conflicts may continue to intensify in the future, because some geopolitical and economic conflicts involve the United States itself, so in this sense, the quality of the dollar and US Treasury bonds as safe-haven assets is not as good as gold, and second, it shows that these central banks may "weaponize the dollar" of the US government in the future Normalized concerns about the impact of a potential default on U.S. Treasury bonds on their foreign exchange reserves have led these central banks to voluntarily diversify their foreign exchange reserves into the commodity sector. In addition, many central banks, including the eurozone, are also seeking to build new international payment and clearing systems outside of SWIFT, which is also a concern about the exclusion of Russian financial institutions from the SWIFT system by the United States after the invasion of Ukraine.

3. Wind data shows that in US dollar terms, gold's share of China's foreign exchange reserves has increased from 1.69% in July 2015 to 4.96% currently. How do you see gold's share of foreign exchange reserves rising, and is there an ideal range for gold's share of foreign exchange reserves?

Zhang Ming: China's foreign exchange reserves are as high as about US$3.2 trillion, and even after two rounds of holdings, the market value of the increased holdings of gold is only around US$100 billion. As the global gold spot market is very limited in trading volume, it is unlikely that the PBOC will buy large amounts of gold in the short term, otherwise this will cause the price of gold to soar. In the future, it is highly probable that the People's Bank of China will continue to increase its holdings of gold. Because there is no yield on holding gold, and the liquidity of gold is weaker than that of financial assets such as treasury bonds and stocks, the ratio of gold to foreign exchange reserves cannot be too high, and the author believes that the proportion of gold in China's international reserves may be about 4-8% in the future, and the probability of more than 10% is low.

4. In your opinion, what is the main driving force behind the rise of gold in this round, and how do you see the recent rise in the US dollar, US Treasury yields, and gold?

Zhang Ming: As mentioned earlier, the main reasons for the current round of gold price increases are: first, the frequent occurrence of international geopolitical and economic conflicts and the expectation of further escalation of future conflicts, which have exacerbated the risk aversion of global investors, and second, the weaponization of the US dollar after the Russia-Ukraine conflict has reduced global investors' confidence in US Treasury bonds and other US dollar assets. Since the vast majority of global gold trading is denominated in US dollars, gold price movements are usually inversely correlated with the US dollar exchange rate movements. The recent rise in the US dollar and US Treasury yields is mainly due to the resilience of the US economy and the higher than market expectations for inflation. The reason why the price of gold is still rising despite the strengthening of the US dollar indicates that the market is gradually beginning to see US Treasuries and gold as two assets with different safe-haven properties or different degrees of safe-haven nature. In other words, some international geopolitical and economic risks that the US dollar cannot hedge, gold can hedge.

5. You have been optimistic about gold in recent years, and once suggested that you can invest in gold when it is below $1,800, and the current gold price has exceeded $2,400. Is gold still a good investment for the average person?

Zhang Ming: When I was still the chief economist of Ping An Securities, on April 6, 2019, our team released a macro report called "Why We Are Bullish on Gold Currently – An Analytical Framework for Studying Gold Price Trends". After that, we saw gold vividly and thought that as long as the price of gold fell below $1,800 per ounce, it was an excellent regular investment window. So far, the price of gold has confirmed our judgment at the time. However, the price of any financial asset can go up and down. The price of gold has risen too fast recently, and it is likely that it has fully absorbed or even overabsorbed the positive news in the market. Gold prices are bound to become more volatile in the coming period. Therefore, it is very unwise for ordinary investors to enter the market on a large scale at this time. Even if you think that the price of gold will continue to rise in the future, regular investment is better than a one-time large-scale investment. The author believes that a better investment strategy is to wait for a significant correction in gold prices in the future before buying appropriately.

6. There is a view that as long as the central bank is still buying gold, the gold rally will not end. In your opinion, can central bank gold purchases be used as a bellwether to judge the trend of gold prices?

Zhang Ming: This view is definitely wrong. Central banks are medium- to long-term investors who are insensitive to short-term price fluctuations. Their increase in holdings only suggests that gold prices may be partially supported by forces in the medium to long term. However, the current rise in gold prices is mainly caused by other investors buying after enthusiasm has risen. We cannot attribute the rise in gold prices to the collective buying of gold by global central banks, nor can we assume that gold prices will only rise in the future because global central banks have increased their holdings of gold. At this time, large-scale leverage into the gold market is a very risky behavior.