The Current Gold Conundrum

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The Current Gold Conundrum

For many centuries gold and money have been synonymous. With the prevalence of paper money in the last couple of centuries, the role of gold changed into becoming the reserve backing paper money with the option to convert into gold, until US President Nixon suspended the conversion of dollars into gold in the 1970s, thus disconnecting the two and creating a life of its own for gold, not as a medium of exchange, but as a store of value.

Over the last decades, gold has evolved as a distinct asset class and a preferred hedge against inflation. Aside from its use in jewellery, demand for gold comes mainly from investment purposes. As a separate asset class and one with low price volatility and proven trust, central banks fortify their reserves by accumulating gold bullions beside other currencies and safe market securities. The same applies to families across the world which put part of their savings in gold for future generations. For the general market, gold is an inflation hedge, thus they invest in gold when they see inflation rising, expecting gold to increase further and preserve the value of their wealth.

With this pattern in mind, a typical lifecycle for gold has developed in financial markets. First, as the economy grows moderately and inflation is under control, the gold price stays low like the 2016-2018 period. Second, as the economy grows rapidly, demand increases and inflation expectation rises, thus people get into gold to hedge against inflation, especially at times when the US Fed is printing excessively like the 2020-2021 period during COVID. Third, as the Fed starts monetary tightening by increasing interest rates to contain inflation, inflation expectation starts to decline and thus gold prices start to stabilize yet at a relatively high level like the 2022-2023 period. Finally, as inflation gets under control and the Fed starts monetary easing with interest rate cuts, inflation expectation declines further and gold as a hedge loses its appeal, so people offload gold pushing its price down, which should have happened lately. This is typically how the cycle has developed and repeated itself over the past decades.

At the moment, gold presents an interesting conundrum with its price reaching new highs while monetary easing is in sight. In the last cycle, gold went through the first 3 phases as the conventional theory would forecast, but then as the Fed paved the way for the easing cycle, gold price didn’t decline or even stabilize, it actually increased and reached new highs, in a critical challenge to the conventional wisdom. With 3 interest rate cuts confirmed in 2024 by the Fed, the stock market has responded as anticipated by rallying, but gold has responded unexpectedly by reaching new highs.

The unexpected rise in gold can be attributed to central bank purchases and increased geopolitical risks. On one hand, central banks typically accumulate part of their reserves in gold, but lately, some central banks, especially the Chinese, are piling up gold at very high rates with annual purchases of over 1,000 tons, thus depending less on US T-bills for their reserves build-up and more on gold which the US has less power on its price determination. In addition, the geopolitical risks are heightened with the increased global tensions and ongoing Middle East crisis, enticing people to run for gold as the conventional safe haven at times of war.

The views about the outlook of gold are very divergent as the gold price crosses 2,400 $/ounce level. Fundamental-driven analysts believe that gold should have declined a while ago and the latest increases are not justifiable. Technical-driven analysts believe that as gold price crosses the 2,200 $/ounce resistance level, it can go upwards to 2,500 $/ounce level, thus, there is still a 5% upside. Political-driven analysts believe geopolitical risks are escalating; thus, gold can stay high for a while and may reach close to 3,000 $/ounce level. Though the majority of opinions agree that the gold rally is at its final sprint, surprises may still happen. In considering the gold outlook in other currencies such as EGP, it is important to consider the expected fluctuation in the currency to come up with a reasonable outlook.

The bottom line, gold has become a distinct asset class, acting mainly as an inflation hedge. Though gold has a typical lifecycle, lately it has derailed from the normal pattern, where gold prices are reaching new highs due to geopolitical risks, despite having the easing cycle in sight and inflation contained. With such a conundrum, the outlook is quite uncertain given the divergence of opinions, making the coming period in the global gold market quite interesting to watch but volatile to trade.

Omar El-Shenety
Managing Partner at Zilla Capital and Adjunct Faculty at the American University in Cairo

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