Five reasons why the gold rally is not over yet!

+28.1%, +27.2%, +28.3% — this is the impressive performance of gold in the first nine months of this year in dollars, euros, and Swiss francs, respectively.

+42.3%, +35.0%, +31.1% — the year-on-year performance as of the end of September was even more prominent.

Given these numbers, the question naturally arises: has the price of gold reached its upper limit, or is it even in a bubble like in the early 1980s, and is a sharp correction imminent? However, Incrementum's managing partner Ronnie Stoeferle said there are good reasons to believe that the price of gold is not yet in an extremely overvalued region.

After adjusting for inflation, gold has yet to reach an all-time high

Since December 2023 (in dollars) and October 2023 (in euros), the price of gold has been chasing one record high after another.

Over the past four years, the price of gold failed to break through the $2,000 mark in several attempts, but it's hard to imagine that in less than six months, the price of gold rose by more than 30% to more than 2,600 US dollars.

However, after adjusting for inflation, the price of gold is still below the record level of 2,646 US dollars set in January 1980, although only slightly lower. Therefore, there is no basis for people to worry that the current price of gold may already be too high.

Another positive aspect is that compared to the latter half of the gold bull market in the 1970s, the rise in gold prices since 2000 has been much more moderate. It should also be pointed out that the way inflation is calculated has changed a lot over the past 40 years.

According to the calculation method used in the 1970s, the inflation rate for the next 40 years or more will be much higher than the figures reported now, and so will the all-time high price of gold adjusted for inflation.

The US Bureau of Labor Statistics, which calculates the consumer price index, lists three major inflation revisions and numerous minor adjustments since 1980. Currently, the Bureau of Statistics's calculations show that compared with 1980, the difference in the inflation rate is about 8 percentage points.

Demand for gold remains high

Among central banks, China clearly slowed the pace of accumulating gold reserves in the second quarter of 2024, but India clearly accelerated the pace. In the second quarter of 2024, India increased its gold reserves by 18.7 tons, which is only slightly lower than Poland. And in the first quarter of 2024, the number of purchases in India was about the same. As a result, the Bank of India's gold reserves increased by 4.6% in just half a year.

Remarkably, after experiencing a severe downturn in 2022, OTC gold trading increased nearly eight times in 2023. This trend continues in 2024 to the present. Compared with the first half of 2023, OTC transactions increased by nearly 60% in the first half of 2024. This was enough to make up for the 6% drop in gold demand in the second quarter of 2024, thus setting the highest value in the second quarter since the World Gold Council began recording data in 2000. This is also the highest value in the first half of 25 years.

However, the central bank's gold reserves are also a reflection of the importance of a country's economy. For example, the Bank of Poland currently has a total gold reserve of 420 tons, surpassing that of the United Kingdom.

In Europe, the economic (power) balance is increasingly shifting from the West to the East.

Poland has one of the fastest growing economies in Europe. Bank of Poland Governor Adam Glapinski (Adam Glapinski) emphasized that Poland aims to hold 20% of its gold currency reserves. The current figure is 14.9%; at the end of 2020, this figure was less than 10%.

Grapinsky's reason for buying gold in large quantities is self-evident: “Our trading partners and investors don't doubt our credibility and solvency, even when dramatic situations unfold around us.”

In other words, in times of serious crisis, that is, at the most critical time, gold can guarantee solvency even better than the main fiat currencies, the US dollar and the euro.

Interest rate cuts boost gold prices

On September 18, amid strong speculation, the Federal Reserve cut interest rates for the first time since the end of July 2019, and the final rate cut unexpectedly reached 50 basis points.

After all, the last time the Federal Reserve cut interest rates by 50 basis points was during economic turbulence in January 2001 and September 2007. Starting a phase of falling interest rates with such drastic interest rate cuts will undoubtedly boost the price of gold. The three rounds of interest rate cuts since the beginning of this century have been the same every time:

In the early 2000s, during the interest rate cut cycle after the internet bubble burst, the price of gold rose from 270 US dollars to around 420 US dollars, an increase of nearly 60%.

In the few years that interest rates were cut after the 2007/2008 global financial crisis, the price of gold soared from around $660 to around $1,600, an increase of more than 140%.

During the 2019/2020 interest rate cut phase, the US economic slowdown, global trade disputes, and the subsequent COVID-19 pandemic caused gold to rise from $1,400 to around $1,900, an increase of more than one-third.

Demand from private and professional investors remains low

Demand for gold from private and professional investors remains very low, particularly in North America and Europe. A survey of investment advisors conducted by Bank of America in 2023 found that 71% of investment advisors invested no more than 1% in gold in their portfolios.

Another 27% hold 1% to 5% of gold. The development of global ETF holdings also reflects the severe underweight of gold, particularly in North America and Europe.

Global ETF holdings have only begun to increase again in recent months, with a total volume of 3,200 tons, which is basically the same level as before the COVID-19 outbreak, but far below the peak during the pandemic in October 2020 and after the outbreak of the Russian-Ukrainian conflict in March 2022 (slightly less than 4,000 tons).

Demand for ETFs in Asia has increased slightly every month in recent quarters, while European ETF holdings did not reverse long-term net outflows into net inflows until May. But in September, capital outflows once again dominated.

In the US, ETF holdings increased for the third consecutive month in September, while net outflow months dominated the previous quarters. As a result, there is still room for a significant increase in ETF holdings.

Considering the gold price trend in recent quarters, ETF holdings in North America and Europe are expected to increase from slightly above 3,200 tons to nearly 6,000 tons if calculated based on historical correlation since 2005. As a result, there is still plenty of room for improvement in this area of demand, and Western European investors in particular tend to invest in a procyclical manner.

Seen from this perspective, Western investors initially declined invitations to the Golden Party. Now that the party is gaining momentum, they don't want to admit that they are the party disruptors.

As a result, they can only attend when the banquet is in full swing, and the “entrance fee” is much higher.

The geopolitical situation remains tense

The Russian-Ukrainian conflict has been going on for two and a half years, and the situation in the Middle East was further intensified by Israel's large-scale attack on the Hezbollah leadership and ground forces invaded Lebanon at the end of September. The danger of a major conflict continues to hang over these two conflict zones like the sword of Damocles.

The increasingly fragile geopolitical situation is becoming more and more evident in the balance sheets of central banks.

Since 2009, central banks have purchased large amounts of gold, and the price of gold has continued to rise, leading to a continuous increase in the share of gold in global international reserves, which has had an adverse impact on fiat currencies. By the end of 2023, the share of gold will surpass the euro.

This means that gold currently ranks second among central bank reserve assets. Although the share of the US dollar in foreign exchange reserves is now far below the 60% mark, the US dollar is undisputed at the top.

The BRICS summit to be held in Kazan, Russia from October 22 to 24 will show whether the trend of abandoning the US dollar will be further strengthened and whether gold, as a neutral reserve asset, will receive additional demand driven by geopolitics.

If you consider the 2024 central bank gold reserves survey results announced by the World Gold Council in June, this development is not surprising. 66% of the central banks surveyed said they expect the share of gold in total monetary reserves to increase slightly after five years. In 2022, that figure was just 46%.

The share of central banks that expect the role of gold to weaken slightly or significantly has been reduced from 24% to 13%. Currently, no central bank anticipates that the central bank's gold holdings will decline in the next year, and 81% of central banks are expected to rise. In 2021, that figure was just 52%.

Notably, geopolitical factors, at least according to this survey, are almost completely irrelevant to the importance of gold as a central bank reserve asset. Concerns about sanctions are almost equally marginal. In contrast, hedging inflation, gold's performance in times of crisis, lack of risk of default, and gold's high liquidity are the most critical reasons why central banks support gold.

However, according to the “Central Bank Gold Reserve Survey”, looking at central banks' demand for gold in recent quarters, it cannot be confirmed that the impact of geopolitical factors and hedging sanctions is relatively small. The average quarterly gold purchase volume before the Russia-Ukraine conflict broke out was 118 tons, and 279 tons after the conflict broke out. The gap between the two is really huge. At the end of the day, actions are more important than words.

conclusions

Ronnie Stoeferle concluded that as of October 10, the fear and greed index for gold was 61, which is just outside the greed range. Given the sharp rise in gold prices over the past 12 months, the possibility of a clear correction cannot be ruled out. However, there are many basic reasons to believe that gold will continue to rise even in the face of setbacks.

He said, “After all, at the beginning of 2024, gold successfully broke the cup handle structure formed since 2011. By the end of September, the price of gold was over 2,600 US dollars, reaching the year-end forecast for 2024 of our incremental gold price prediction model. Given the further deterioration in economic and (geopolitical) conditions, the target price of slightly above $4,800 in the model will be viewed as a conservative forecast by the end of 2030. Against this backdrop, gold is still cheap even though it has risen sharply last year. As Michael Kosares once aptly said: 'In a bull market, watching is the worst place! ' ”