What the surging gold price says about a dangerous world

Less than a mile from Singapore’s luxurious Changi Airport sits a rather less glamorous business park. Residents of the industrial estate include freight and logistics firms, as well as the back offices of several banks. One building is a little different, however. Behind a glossy onyx facade, layers of security and imposing steel doors, sits more than $1bn in gold, silver and other treasures. “The Reserve” hosts dozens of private vaults, thousands of safe deposit boxes and a cavernous storage room where precious metals sit on shelves rising three storeys above the ground.

After four years of retrofitting, the complex is almost complete. Its grand opening will come at an opportune moment: gold is in the midst of an extraordinary renaissance. Over the past year investors have piled into the metal, driving its price up by 38% to over $2,700 per troy ounce—a record high (see chart 1). The buzz has reached unusual places: gold bars have hit the shelves of Costco, an American retailer, and CU, a South Korean convenience-store chain, as the resurgence of inflation and fears of war drive consumer enthusiasm. Central bankers are also getting involved, as financial fragmentation increases appetite for an ancient asset. The world has entered a new golden age.

Professional investors are often scornful of precious metals, for good reason. Gold produces no income. Warren Buffett, one such investor, says that bets on gold are made by those who fear other assets, and believe that the ranks of the fearful will expand. Among American institutional investors managing more than $100m in assets, only a quarter report owning shares in gold exchange-traded funds (ETFs), according to Dirk Baur and Lai Hoang of the University of Western Australia. Only 1.5% of such firms’ assets are in gold. All this helps explain why holdings in gold ETFs have failed to rise, even as the price of the metal has climbed (see chart 2).

The biggest fans of precious metals do not always help themselves. Goldbugs tout outlandish predictions to justify their bets. A looming American debt default is a perennial favourite; the supposed launch of a gold-backed currency by China and Russia is a new and even more fantastical forecast. But today there are more people convinced that things really are heading south than just a few years ago, and there are more rational reasons to believe so.

Family offices, the preferred investment vehicle for the privately wealthy, are growing fast—assets under management have risen from $3.3trn in 2019 to $5.5trn today—and many investors want to protect their wealth from dire outcomes. The value of a currency may fall both against others and in terms of its purchasing power; gold’s relatively fixed supply and historical popularity encourages investors to believe it can protect them against surging prices and misjudged policies. According to Campden Wealth, a data provider, over two-thirds of family offices invest in gold. Lots of demand comes from Asia: China and India make up a fifth of the world’s economic output, yet count for half of consumer purchases of physical gold. German and Swiss nationals are the only Europeans similarly enthused (see chart 3).

Moreover, Chinese and Indian fondness for gold is growing. In China a property crisis has prompted people with capital to look elsewhere. Purchases of gold bars and coins rose by 44% in the year to June against the previous 12 months. As India gets richer, more people are able to buy gold. One consequence is that gold-backed lending has taken off. Muthoot Finance, one such lender, has seen its share price almost triple over the past five years.

But it is another class of investors—perhaps the most paranoid and conservative of all—that has really driven the recent rally: reserve managers at central banks. Gold’s share of central-bank reserves has declined for decades, from almost 40% in 1970 to just 6% in 2008. More recently, though, its share has steadily climbed, rising to 11% last year, the highest in more than two decades (see chart 4).

Russia’s invasion of Ukraine, and the subsequent freezing of its foreign-currency reserves, was a pivotal moment. It demonstrated to reserve managers that if their country was put under sanctions, American Treasuries and other supposedly safe assets denominated in Western currencies would be of no use. Since the start of 2022, monetary authorities in China, Turkey and India have bought 316, 198 and 95 tonnes of gold respectively, according to the World Gold Council, an industry group. Instead of investing in ETFs, central banks mostly accumulate physical gold, and make sure that they have it close to hand: just as financial assets face the possibility of seizure, so does gold held overseas. The British government, for instance, has refused to repatriate dozens of tonnes of gold to Venezuela, since it does not recognise Nicolás Maduro as a legitimate leader.

Not all of the central banks snapping up gold have difficult relations with the West. The Monetary Authority of Singapore has accumulated 75 tonnes since the start of 2022. The National Bank of Poland has raised its holdings by 167 tonnes over the same period as part of a strategy to keep 20% of reserves in gold. Adam Glapinski, the bank’s president, refers to gold as a strategic hedge, as it has low correlations with other asset classes. “The price of gold,” he said in 2021, “tends to be high precisely at times when the central bank might need its ammunition most.” In September Laos opened up a flashy monument to the new golden era: a gold-panelled bullion bank in its capital.

Central-bank demand seems unlikely to fall anytime soon. In a survey of sovereign investors conducted by Invesco Asset Management this year, none of 51 central banks expected to reduce their gold allocation in the next three years, and 37% expected to increase it. Among central bankers, some 56% believed gold offers protection against the “weaponisation” of central-bank reserves and 70% saw it as a hedge against inflation.

Demand from central banks, which invest for security not returns, helps explain why gold’s relationship with interest rates has broken down. The metal usually does poorly when real yields on safe government bonds are high, which means they provide a solid return even after inflation. When returns to the safest bonds are low, gold has tended to rally. In a low-yield environment, investors are more likely to consider an asset that produces no income. Since the end of 2021, however, the once-trusty correlation has collapsed. Gold has climbed in price even as yields on ten-year inflation-protected American Treasuries rose from minus 1% to around 1.8%. When real yields were last as high, gold was worth around $1,000 per troy ounce, almost two-thirds less than its current price.

How useful will gold be in a crisis? Nicholas Mulder of Cornell University notes that it can be sold in small quantities in the politically neutral Gulf, in exchange for a variety of currencies. Although Russia was cut off from Western gold markets by the restrictions deployed against the government, and some firms have been punished for dealing with Russian miners, a suspicious surge in gold imports by Switzerland from the United Arab Emirates in the months following the invasion of Ukraine suggests that Moscow was managing to market its gold. Preventing the sale of an asset that can be smuggled around the world in small quantities, and melted down, is an all but impossible task.

Ultra-rich investors may buy more gold, too. But for gold purveyors the real target is institutional investors: bringing in just a sliver of the tens of trillions of dollars they manage would be a huge boon. Such purveyors may be in luck. Goldman Sachs, a bank, notes demand for gold ETFs tends to rise only as American interest rates fall, not in anticipation. Typically, a rate cut of a quarter of a percentage point increases gold ETF holdings by 60 tonnes—currently $5bn in value—over the subsequent six months. Mr Buffett’s criticism that gold requires fear, and a belief that the fear will spread, is true. At the moment, though, there are a lot of fearful investors.

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