Text/CICC Asset Research: Li Zhao, Qu Botao, Yang Xiaoqing
From Europe and the United States to Asia
Gold is a major asset class priced globally, and European and American funds have played a leading role for a long time. After entering 2022, the pricing power of gold seems to have begun to change marginally: European and American gold ETF holdings continue to flow out, and major European and American central banks have not significantly increased their holdings of gold, but gold prices have continued to rise and hit record highs, reflecting the decline in the pricing power of European and American funds for gold. We find that the market impact of Asian funds has increased significantly, forming an "Asian shock" in this round of gold market.
Chart: Gold-backed ETFs in Europe and the United States saw outflows, but gold remained up
Source: Wind, Bloomberg, CICC Research
Chart: The size of central bank gold reserves in Europe and the United States is basically unchanged
Source: World Gold Council, CICC Research
In "Can Gold Still Be Bought?", we argue that the "anchor" of gold pricing is not only the US Treasury interest rate, but also the amount of gold purchased by global central banks is another "anchor" of gold pricing.
Since 2022, the top five countries with cumulative increase in global central bank gold reserves are China, Turkey, Poland, Singapore and India, with a cumulative increase of more than 700 tons, accounting for 84% of the increase in global central bank gold reserves in the past two years.
Chart: Higher central bank net purchases drive gold prices higher
Source: Wind, Bloomberg, CICC Research
Chart: The top five countries with global gold reserves are concentrated in Asia
Source: World Gold Council, CICC Research
In the era of de-globalization and de-dollarization, it is necessary for central banks to diversify their asset allocation to reduce risks. Asian countries' gold reserves are lower than those of European and American countries, so there is a stronger incentive to increase gold allocation to diversify risks.
Chart: The proportion of gold in foreign reserves in Asian countries is lower than that of European and American countries
Note: Data as of February 2024
Source: World Gold Council, Haver, CICC Research
Outside of central banks, demand for gold from the private sector in Asia is also on the rise, with holdings in Asian gold-backed ETFs increasing by more than 25% from around 120t in 2022 to around 150t, while holdings in gold-backed ETFs in Europe and the US fell by 19% over the same period.
Chart: Holdings in Asia Gold ETF rose, while holdings in Europe and the US declined
Source: Wind, World Gold Council, CICC Research
Reflected in the Chinese market, we see that the premium of Shanghai Gold to London Gold is expanding and has reached an all-time high.
Physical gold import data also supports the impact of Asian demand on the gold market. As the world's leading gold smelter, Switzerland accounts for about 30% of global gold exports. In the past decade, India and China have imported about 8,000 tonnes of gold from Switzerland, while major countries in Europe and the United States have only imported about 4,000 tonnes.
The supply of gold is relatively rigid, and Asian gold purchases form a key marginal demand in the gold market, which has a significant impact on the original gold market.
Chart: India and China have been the main importers of Swiss gold for more than 50% in the last decade
Source: Haver, CICC Research
From financial properties to monetary properties
From the dominance of Europe and the United States to the impact of Asia, it essentially reflects the weakening of gold's financial attributes and the strengthening of its monetary attributes. If gold is used as a financial asset, its opportunity cost is the funding rate, so gold is highly negatively correlated with the real interest rate of the 10-year US Treasury bond. This is the concentrated embodiment of gold's financial attributes, and it is also the core logic of European and American funds trading gold.
Chart: Gold has a significant negative correlation with real interest rates before 2022 and begins to "de-anchor" after 2022
Source: World Gold Council, CICC Research
After 2022, the rise in gold and the "de-anchoring" of real interest rates are ostensibly due to the weakening of the influence of European and American funds and the strengthening of the influence of Asian funds, which is essentially the return of gold's monetary attributes. Gold is a substitute for the US dollar system, and the credibility of the US dollar system is negatively correlated with the price of gold, reflecting the monetary attributes of gold.
Chart: The US dollar retreated in the share of global central bank foreign exchange, corresponding to higher gold prices
Source: Wind, CICC Research
In recent years, the US has continued to expand sharply, the scale of debt has accumulated rapidly, and the issue of fiscal sustainability has raised social concerns, and Fitch has downgraded the credit rating of US bonds[1], which has become the internal cause of the credit decline in the US dollar system. We can see that the size of US debt as a proportion of GDP is highly positively correlated with the trend of gold, which confirms that the decline in the credibility of the US dollar system is good for gold.
Chart: The rise in US debt as a share of GDP corresponds to an increase in gold prices
Source: Wind, CICC Research
Rising geopolitical risks and the rise of anti-globalization are external factors for the decline in the credibility of the dollar system. The freezing of foreign exchange reserves in some countries amid the geopolitical conflict between Russia and Ukraine has accelerated this process. The combination of internal and external factors has reduced the credibility of the dollar system. In response, Asian central banks have used gold as a hedge to promote the return of gold's monetary attributes, keeping gold strong against the backdrop of high interest rates.
From the value of the transaction to the value of the allocation
From Europe and the United States to Asia, from finance to currency, the switching of macro drivers and market trading logic has created objective trading value for gold investment in the past two years. Gold will not only be the top performer in 2023, but will also lead the global asset class in 2024.
Chart: Gold leads the global asset class in 2024
Source: Bloomberg, Wind, CICC Research
Since 2022H2, CICC's asset class team has upgraded gold to overweight as a strategic asset in the next few years, and has conducted continuous tracking and analysis (for details, see "2023 Outlook for Major Assets: Extreme Changes", "U.S. Inflation Comes Again, Gold Allocation Opportunities Highlighted", "Can Gold Still Be Bought", etc.). At the current trading point, gold valuations may already be above the equilibrium price, and the risk of high volatility increases (see the next section for details), so we recommend modestly downplaying the short-term trading value of gold and focusing on the long-term portfolio allocation value of gold.
First of all, the correlation coefficient between gold and major assets at home and abroad does not exceed 0.4, and adding gold to the portfolio is conducive to risk diversification.
Chart: Gold has a low correlation with major overseas asset classes
Note: The data range is from 2004 to the present
Source: Wind, Bloomberg, CICC Research
Chart: Gold also has a low correlation with major domestic asset classes
Note: The data range is from 2004 to the present
Source: Wind, CICC Research
The calculation results show that gold has a good allocation value for both domestic and foreign investors.
We construct our portfolios using overseas assets and domestic assets, with the London gold price for the overseas portfolio and the Shanghai gold price for the domestic portfolio. Since 2004, the return of London gold has been basically the same as that of the S&P 500, at around 8-10%, and the return of Shanghai gold is close to that of the CSI 300, at around 8%.
Chart: Since 2004, the annualized return of London Gold has been comparable to that of overseas equities
Note: The data range is from 2004 to the present
Source: Wind, Bloomberg, CICC Research
Chart: Since 2004, the annualized return of Shanghai Gold has been comparable to that of domestic stocks
Note: The data range is from 2004 to the present
Source: Wind, CICC Research
For overseas investors, the Sharpe ratio of the 60/40 portfolio of equities and bonds has increased from 63% to 75% with the addition of 25% gold. The performance of the 60/40 60/40 portfolio has also increased significantly, with the same proportion of gold also improving the performance of the domestic stock and bond portfolio, from 34% to 45%.
Chart: Adding gold to the 60/40 portfolio of domestic equities and bonds can increase the Sharpe ratio by about 11%.
Note: The data period is from 2004 to the present, and the yield used for the calculation of the Sharpe ratio is the 3-month Treasury bond rate
Source: Wind, CICC Research
From the perspective of maximum drawdown, adding gold to overseas and domestic equity and bond portfolios can reduce the maximum drawdown by about 11% and 8% respectively.
Chart: Adding gold to the 60/40 portfolio of overseas equities and bonds can reduce the maximum drawdown by about 11%.
Note: The data range is from 2004 to the present
Source: Wind, Bloomberg, CICC Research
Chart: Adding gold to the 60/40 portfolio of domestic stocks and bonds can reduce the maximum drawdown by about 8%.
Note: The data range is from 2004 to the present
Source: Wind, CICC Research
It should be noted that if we extend the statistical interval of overseas assets to 1976 - the current Sharpe ratio contribution of gold to the equity and bond portfolio is not significant, which may be due to the low level of returns of gold assets during the period 1980-2000.
Chart: Using data from the 70s, gold's contribution to the Sharpe ratio of the 60/40 overseas equity and bond portfolio is not significant
Note: The data period is from 1976 to the present, and the yield used for the Sharpe ratio calculation is the 3-month Treasury rate
Source: Wind, Bloomberg, CICC Research
Through the above examples, we can see that adding an appropriate amount of gold to the portfolio in the past 20 years can reduce the portfolio volatility, optimize the portfolio Sharpe ratio and maximum drawdown, but also need to avoid the long-term downward trend of gold.
The risk of short-term shocks in gold has risen, but the medium- and long-term rally may not be over
We construct a four-factor model to explain gold prices using US Treasury real interest rates, central bank net purchases, the US dollar index, and the size of US debt. Models show that in the current macro environment, the equilibrium price of gold is around $2,000/oz (see Can Gold Still Be Bought), and if Treasury rates fall back to the interest rate pivot, gold could rise to $2,400/oz.
Chart: The four-factor model suggests that the current gold price may already be above the short-term equilibrium level
Note: The central bank's net gold purchase data for the first quarter is based on the monthly central bank gold reserve changes, which may differ from the actual value
Source: Wind, Bloomberg, CICC Research
At present, the U.S. Treasury interest rate has not fallen significantly, but gold once hit $2,400 per ounce, and the model residuals have reached an all-time high, which may indicate that short-term gold valuations have been overvalued. Factors such as the fermentation of geopolitical issues in the Middle East, the inflow of speculative long funds, and the seasonal demand for gold purchases during the Vaishyas festival in India may be the short-term drivers of the rapid rise in gold prices.
Chart: India's gold imports typically increased sharply in April-May
Source: Wind, Bloomberg, CICC Research
Chart: Gold speculative net long position increased
Source: Wind, Bloomberg, CICC Research
We believe that if geopolitical risks cool down or speculative funds take profits, gold is at risk of high volatility. Gold fell 2.4% on April 22, the biggest one-day drop in two years, validating our judgment.
However, in the medium to long term, we believe gold's rally may not be over yet.
Looking at cyclical factors first, the strong growth in the US in Q1 may have benefited from supply-side improvements, or it may only reflect short-term data disturbances, which may not necessarily form secondary inflationary pressures ("Challenges and Turnarounds in the Interest Rate Cut Trade"). The CPI forecasting model of CICC's major assets shows that the recent US CPI has been greatly affected by the abnormal fluctuations of individual sub-items, and inflation is still in a downward channel. If U.S. inflation improves as expected and the Fed starts cutting interest rates, it will drive U.S. Treasury rates down. Gold has not really decoupled from U.S. Treasury interest rates and is still suppressed by high interest rates, and the decline in interest rates may provide new support for gold's performance.
Chart: Real interest rates and the U.S. dollar index weighed on gold's performance, but central bank purchases and the size of U.S. debt supported gold prices
Note: The central bank's net gold purchase data for the first quarter is based on the monthly central bank gold reserve changes, which may differ from the actual value
Source: Bloomberg, Wind, CICC Research
From the perspective of structural factors, the accumulation of debt problems in the United States, the frequent occurrence of geopolitical events, and the pattern of de-globalization and de-dollarization may be further deepened, or promote global central banks to continue to increase their holdings of gold, providing support for gold prices. In summary, we warn of short-term volatility risks for gold, but remain bullish on the medium- and long-term allocation value of gold.
CICC's in-depth research series on major assets:
"2024 Outlook for Large Asset Classes: Risks and Opportunities of Valuation Changes" (2023.11.12)
"How Much U.S. Treasury Interest Rates Are Overshooted" (2023.10.23)
"Has the U.S. Entered an Era of High Interest Rates?" (2023.9.25.)
"Outlook for the Second Half of 2023: Expected Swing" (2023.6.12)
"Financial Risks in Europe and the United States from a New Perspective" (2023.4.25)
"2023 Outlook for Major Asset Classes: Extreme Change" (2022.11.14)
"A New Perspective on Inflation Variables and Asset Changes" (2022.10.30)
Global Perspectives: The Future of Personal Pensions (2022.9.4)
Demystifying the Rotation of Stocks and Bonds: The Timing Signal of Risk Premium(2022.8.27)
"Outlook for the Second Half of 2022: The Next Stop in the "Stagflation Trade" (June 1, 2022)
"Will the U.S. Treasury Interest Rate Break 3 at the Acceleration of Balance Sheet Reduction?" (2022.4.13)
"Asset Selection under Oil Price Shocks and Recessions" (2022.3.28)
2022 Treasury Rate Outlook: Atypical Rate Hikes and High Volatility Markets (2021.12.18)
"2022 Asset Allocation Outlook: Seeking Progress While Maintaining Stability" (2021.11.8)
"Thematic Strategy: How Much Can U.S. Treasury Rates Rise?" (2021.10.11)
"Thematic Strategy: How Do U.S. Treasury Rates Affect the Chinese Market?" (2021.8.18)
"2021 Medium and Large Asset Allocation Outlook: Recovery Dislocation, Asynchronous Rotation" (2021.6.15)
"Thematic Strategy: Capturing High-Order Signals of Asset Rotation" (2021.5.9)
[1]https://www.fitchratings.com/research/zh-cn/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-02-08-2023
Article source:
This article is excerpted from "New Trends and Opportunities for Gold", which was published on April 23, 2024
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