Are record highs on gold a matter of time?

Gold has always been investors' answer to uncertain times. Looking at the behavior of prices in recent months, it seems that we are currently living in such times. We must deal with extremely high inflation, high interest rates, war, possible recession, or political games between the world's largest powers. Although uncertainty has been with us for some time, gold has struggled to provide a sense of security for a long time. However, now that we have so many unknowns, can gold still be the answer to risk and uncertainty?

High interest rates, but not for long

The year 2022 was very tumultuous - we observed gold prices reaching almost record levels in the aftermath of the outbreak of Russian invasion of Ukraine. On the other hand, we experienced excessive inflation, which according to historical accounts should support higher gold prices. However, the situation is not that simple, as high inflation encourages central banks to raise interest rates, which in turn tend to be very negative for gold. Gold does not pay interest like bonds or deposits, so when seeking security, investors in times of uncertainty in a high interest rate environment tended to look favorably on gold. Interest rates have risen in many countries to levels not seen in many years, even though it seemed that zero interest rates would remain with us forever. However, many central banks have already ended their rate hikes, and theoretically this could be a good time to buy gold and other metals.

This was exactly the case in 2018 when the Fed ended its rate hike cycle, and just six months later in June 2019 began to lower interest rates. This strengthened earlier gains in gold, resulting in reaching record price levels in 2020 (further supported by central banks' COVID-related actions). However, currently prices are near record levels, so the question arises whether we can expect another wave of increases at new and yet unexplored levels?

Central banks are preparing for difficult times

For some time now, we have been observing not only strong demand for physical investment gold in the form of bars or coins, but also demand for physical gold from central banks. Since 2010, the average demand for gold by these institutions has been about 400-500 tons annually, which accounted for less than 10% of the total annual demand for gold. However, in 2022 we witnessed a breakthrough. Central banks purchased over 1,000 tons of gold throughout the year, which was not only a historic record, but also accounted for over 20% of the total global demand and almost exceeded the entire investment demand. The purchases of gold by central banks may signal that the world is quite concerned about the future. On the other hand, it is worth noting that among the buyers we have primarily central banks from developing countries or those struggling with inflation. Among the largest buyers were China, India, Turkey, and Russia. On the other hand, the leader in purchases this year is Singapore, which may change the perception that only central banks from emerging countries buy gold. The first quarter of 2023 was also exceptional in some respects, as never before has so much gold been purchased at the beginning of the year. It was as much as 228 tons of gold in Q1 2023, which is roughly the same amount that central banks purchased throughout the whole of 2020.

Can the banking sector and the United States itself collapse?

The market has been under attack from various risk factors in recent years. First, there was the Covid pandemic, then the war in Ukraine, and now it is the global expectation of a recession in times of high inflation. Problems in the US banking sector surfaced in March this year, which reminded us of the crisis of 2007-2009. US regional banks were struggling with the decline in the value of their assets and balancing this with deposits, resulting in the government or other larger private banks taking over smaller entities. Although the situation seems to be under control, there is still considerable uncertainty among investors.

Another source of potential risk is the debt crisis in the United States, which further boosts the price of gold. The United States has exceeded the debt limit of 30 trillion dollars this year and shows no signs of stopping at this level. US President Joe Biden and the Democrats are fighting to increase the debt limit in the US, not only for the state to continue to operate normally but also for servicing of the current debt. Theoretically, if an agreement with the Republican Party is not reached, we may witness problems with the repayment of US government debt. This problem is compounded by high interest rates, which cost of servicing debt.

Further tensions between the US and China

Relations between the two largest economies in the world have significantly deteriorated since the appearance of "spy balloons" on US territory, which US blamed on China. In addition, China continues to increase tension over Taiwan, which is strongly supported by the United States. At this point, there is no solution to this situation, and its continuation will not serve global economic recovery, which may further increase demand for gold.

Paper gold is not popular

In the last few months, we have observed a significant decrease in interest in exposure to gold through so-called ETF funds. In the past, changes in the attitude of ETF funds, which hedge themselves with physical gold, were driven by short-term market sentiment. The banking crisis, the decline in yields, and expectations of the end of rate hikes led to a slight increase in interest in gold ETFs, but for now, it is not large enough to fundamentally create a deficit in the market. At this point, for many quarters, we still see an excess of supply over demand, although this may change with possible rate cuts in the US, which will stimulate demand for ETFs and tip the scale in favor of demand over supply.

Can we expect new records?

In some ways, gold has reached new historical highs, although we can only speak of a partial success. New historical highs at $2,078 per ounce were reached a day after the Federal Reserve's decision on May 4. However, record highs were reached only on the futures market as spot gold traded a few dollars below all-time highs.

Nevertheless, looking at price action and many market uncertainties, and with almost no chance of strong global recovery under current fundamentals, it seems that gold has a good chance of reaching new highs in the future. It should be noted that other precious metals continue to trade significantly off the record highs and seem to be strongly oversold compared to other asset classes. This is especially true for silver or platinum which underperformed gold significantly.

Of course, should inflation resume climbing and odds for Fed hikes rise, the outlook for gold may change. On the other hand, additional rate hikes by the Fed would risk greater economic collapse.