On December 2023 1st, the price of physical gold set a new record by increasing to $2,150 an ounce (35grams). Over the past two years, gold has repeatedly broken its past records, meanwhile the US Federal Reserve’s federal funds effective rate was raised from nearly 0% to 5.33% between November 2021 and November 2023. Despite a sudden increase in interest rates, spot gold prices didn’t fall but have rather stagnated at record highs, which goes against gold price’s past evolutions as we will see later. Relatively unaddressed in financial media, physical gold would be about to skyrocket in the next decade according to some analysts.
Before reviewing the gold price forecasts and factors, let’s go over gold’s history and main features.
An unique asset
First mentions of gold use in societies trace back to Ancient Egyptia, but even older golden artefacts have been found in 4500 BC.
Gold has quickly fascinated humans for its unique features. Gold has always been exploitable in very small quantities, making it a rare metal. All gold resources extracted or known since the emergence of sedentary societies could be put in a 20.9-metre cube that could be stored… just beneath the Eiffel Tower.
Gold stands out by its distinctive color culturally praised (yellow is traditionally associated with the sun, which is symbol of divine power) and by its purety. Gold is stainless to both water and air and resists to every kind of acids. Physical resistance and scarcity explain the all-time high value given to gold. Lastly, despite being scarce, gold is itself a flexible metal, which explain its wide use for artistic or monetary purposes.
Indeed, gold’s resistance to natural elements, its high perceived value shared across cultures coupled with the ability to manufacture easily items of different sizes and shapes using this metal had early made it the idealistic currency.
As a reminder (see my article on the history and functions of currency), a currency has always serves three functions:
–intermediary of exchanges: it is more convenient to use a divisible item (gold coin, rice, spice) as a go-between for transactions than exchanging goods for other goods.
–standard of pricing system: a market is a system of prices used to give a value equivalence between goods and services that are not equivalent. It fundamentally needs a single standard.
–storehold of wealth: a currency in itself has no value but its purchasing power, i.e its ability to buy X amount of products. A currency that rapidly loses its purchasing power will be abandoned.
The last function is particularly well saved by gold. Since gold’s intrinsic value doesn’t alter, it is the excellent way to “store” purchasing power. For these reasons and as seen in previous articles, gold has been early and for a long time used as the basis of monetary systems.
In July 1971, 27 years after the foundation of the gold-backed monetary system Bretton Woods, US President R.Nixon announced the end of the dollar’s insured convertibility into gold at a fixed rate. Gold starting this time used to be a currency to be just a financial asset.
Gold and real interest rates
Precious metals (gold, silver, palladium) doesn’t offer return, contrary to most real and financial assets. Someone investing 1,000,000$ in stocks or real estate properties will except a return respectively made of dividends, rents…
For this reason it is very hard to build a model determining the price evolution of gold. However, based on past observations analysts have detected a strong correlation between gold price change and real interest rate change.
Real interest rates are the difference between Nominal short term interest rates set by the Central Bank in a fiat currency system (current system) and the inflation rate. What is the similarity between inflation rate and nominal interest rate?
Federal interest rates determine currency’s scarcity. When short-term interest rates go down, commercial banks have an expanded access to Central Bank’s liquidity or also called monetary base. Monetary base being the commercial banks’ basis for creating money through granting loans to housholds and companies, decreasing short term interest lead to expansion of monetary aggregate M2.
When money supply increase durably quicker than production (GDP growth), i.e when the monetary signs that circulate in the economy increase faster that the amount of goods and services produced that could be exchanged for these signs, value of money logically declines. This situation corresponds to negative interest rates, when nominal rates goes lower than inflation.
From an investment perspective, it means that someone who invested 100$ in a US 10-year Treasury Bond will earn a yield to maturity lower than inflation rate, which means that the 100$ he will be given back in 10 years + coupons won’t compensate for the increase of prices 10 years from now. In a word, the 100$ have lower purchasing power due to low nominal rates.
In this situation, the investor would increasingly opt for buying 100$ worth of gold, which given its physical properties fundamentally conserves wealth.
This chart illustrates that, when real interest rates decrease up to being negative (right scale), gold prices tend to go up (left scale).
Gold price have experienced three substantial increase since 1970:
–between 1975 and 1981, when rising inflation due to energy prices and somewhat loose monetary policy lead to negative interest rates.
–between 2002 and 2011. The Fed slashed federal rates in the aftermath of the dotcom bubble burst, the 11/9 terror attack and the US military engagement in Afghanistan and Irak. After a sudden increase between 2006 and early 2007, nominal rates reached zero in response to the Great Financial crisis
–starting 2019, when the Fed renounced to pursue federal rates increases but notably following the COVID-19 first wave, which pushed Western governments to keep nominal rates near 0% and increase their balance sheets.
The implication of this is a positive correlation between money supply and gold prices, since low nominal rates lead to durably more credit supply. The two famous gold investors Ronald Stöferle et Mark Valek have used this implied correlation to build a first predictive model of gold evolution.
The model Incrementum, from the name of the analysts’ investment firm relies on two factors, the growth of monetary aggregate M2 (captures the growth of credit) and the % of this aggregate covered by monetary base. The results of the model is a distribution of gold ounce price’s probabilities by 2030, updated every month and consultable on their website.
Here is the distribution published on January 2022.
Data slightly change but the observation remains the same:
The analysts give gold price a probability-weighted peak of 5,829$ by 2030, which marks a 185% increase from today (February 8th 2024).
Gold and the financial system stability
The interaction between gold and interest rates reflects the rational choice for gold when money is not remunerated as much as prices increase.
However, gold has also a sensitivity to other aggregates which added together reflect the stability of the economy and financial system as a whole. It is a separate notion; several years of low nominal interests doesn’t necessarily jeopardize the sustainability of a capitalist economy.
The same analysts investors Ronald Stöferle et Mark Valek have recently built a second model which this time puts gold prices in a tandem with the S&P 500 evolution.
The Synchronous Bull Market Indicator (SBMI) was initially developed by former investment banker Dietmar Knoll. Knoll pointed out the negative correlation between gold cycles and stocks market cycles, and the dependence of these two markets on two factors only: the growth of currency supply as seen below, and the confidence of investors.
The confidence of investors defines their appetite for risk so their preference for riskier assets like stocks at the expense of safer but zero-return assets like gold.
As seen above, every rise of the S&P500/gold ratio (blue) went with a gold bear market and a stock bear market , like between 1982 and 1998, because the investors were confident on the future of the growth so they were keener on buying stocks.
There has also been a stock bull market between April 2009 and February 2020, with the S&P 500 being multiplied by 3.88 during that period. Meanwhile, gold prices declined throughout 2013 and remained stagnant until 2019, as shown below.
The model proposes to anticipate the turning point of gold and stocks evolutions by comparing the current S&P500/gold ratio with its moving average, as pictured below (the 40 last month moving average is used there:
The model announces that a Gold bull market has potentially started since December 2021 because the S&P500/gold ratio has decreased to become equal to its 40 months moving average (the deviation went from positive to zero) which announces a future ratio below the moving average (negative deviation).
This turning point reflect the Investors’ changing trust on the future prospects of growth. A lot of system risks undermine future world growth which makes think US stocks won’t offer sizeable returns: fragmentation of globalization which will increase production costs, geopolitical tensions in Ukraine, Middle East and East Asia which weigh on supply chains and energy prices, cost of energy transition, the sustainability of the huge US public debt…
This declining confidence about the system dynamism coupled with the increasing money supply lead to high gold prices by 2030 according to this model:
The model anticipates gold prices ranging from 4,150$ and 6,350$ an ounce, i.e between x2 and x3 more than today, even given conservative assumptions. Indeed, 7% money supply growth is the “high-range hypothesis” but Dietmar Knoll underlines that during the inflationary period between 1970 and 1980, the 8-year average money supply growth was above 10%, but at the time US had little public and private debt.
A last condition makes the current situation radically different from past gold price increases.
Changing geopolitical order and the decline of the USD $
Over the past 10 years, major macroeconomic and geopolitical change are accelerating the decline of US $ as a reserve currency, beyond the United States’ internal weaknesses highlighted by Ray Dalio. These evolutions favours gold:
=> The United States have started in 1944 a Long term debt cycle, which according to investors like Ray Dalio is today coming to an end (read One lecture – Principles for dealing with the Changing World Order: Why Nations rise and fall, by Ray DALIO (2/4) in detail ). As shown above , the gradual decline of real interest rates after each economic crisis has gone hand in hand with a constant expansion of US public and private debt as well as an expansion of US stock and real estate markets. The boom of financial assets and debt represents the boom of promises of incomes. Debt is a promise of future pay-back, a stock price reflects is a promise of future revenues. All these claims on the real economy occurs while the real economy’s future growth prospects are worsening. As described by Ray Dalio, this situation will lead foreign holders of debt to a first gradual then brutal sell-off of the paper money for buying hard assets like gold. A massive selling of US Treasury bonds and other US denominated debt by foreign investors will spark a massive influx of $ (and its satellite currencies like the €) to the emitting country which will make inflation skyrocket.
Even if the US avoid this situation or postpone it indefinitely, the situations remains unchanged: the irrevocable imbalance between the claims on the real economy and what the economy can produce of incomes to meet these claims will entail a decline of the value of the dollar, which mechanically means a higher value of gold denominated in $.
=> Non-Western countries that are more or less hostile to the US are not only turning away from dollar-denominated assets for the reasons quoted above, but they also develop alternative means of payment and currencies backed on gold:
-China has the ambition to promote the Chinese Yuan as a international transaction currency and even for some analysts, as an international reserve currency. It logically results from its dominant trade and industrial position: China does not see the interest of being paid in dollars and not yuan from countries that are net importers of Chinese products. At the same time, US’s budgetary and monetary irresponsibility just pushed Chinese leaders to realise that their huge amounts of US Treasury Bonds could never be paid back. It explains why since Fed’s QE after the Great Financial Crisis, the People’s Bank of China’s holdings of US Treasuries have stagnated then fall continuously, from $1.3trn in 2014 to less than $900bn end of 2022. At the same time, the PBOC has consistently purchased physical gold while disclosing underestimated amounts. It is acquiring gold abroad with US dollars via large Chinese state banks to bullion banks and refineries before having the metal shipped to Beijing without a trace in customs reports. Cumulated and corrected private and public reserve of gold in China would actually top 28,000 tons, far more than the US. This intense but discrete activity confirms the hypothesis China may prepare a gold-backed international yuan.
-Russia has been a long-standing advocate for restoring a gold standard system. Since the 2014 sanctions following the annexion of Crimea, it has largely de-dollarize its economy and banking system and bought a lot of gold. With also a public debt at only 22% of its GDP, Russia is by far the best prepared country amid the BRICS to adopt a gold standard.
-The rest of the BRICS+ and the 30 countries who show interest in joining it is also actively buying physical gold and simultaneously, dropping dollar-denominated assets from their sovereign wealth funds and central banks’ balance sheets. Globally speaking, there is a shift of physical gold from the West to the East, with China, India (it has the higher private holdings of gold), smaller Asian countries and now Middle East nations buying a lot of physical gold in and outside the markets. In 2024, Russia will assume the presidency of the BRICS+ and organise over 200 meetings throughout Russia with existing and applying state members. Russian officials clearly stated they will promote the development of an alternative trade settlement arrangement. It would in the mid-to-long term – only – take the form of an international currency used only for settling trade exchanges between members and backed by a basket of the BRICS+ members currencies, by commodities and…gold.
As a conclusion, all these trends have accelerated dramatically following geopolitical events. Following the Russian-Ukrainian war, the West banned Russia of using payment system SWIFT and seized its euro and dollar-denominated assets, which factually has been very negatively welcomed in the rest of the world. The weaponisation of the reserve currency against the 11th world economy, whether it is justified or not, has urged a lot of these countries to silently but consistently find alternatives, and gold by its neutrality is an alternative. The risk of escalation in Middle East after Hamas attacks, China and Taiwan, as well as the promising tensions linked to the 2024 American Presidential Election all press gold prices’ upward.
All these factors mentioned in my article have a common denominator: in a world of rising risk, whether it is financial, geopolitical or economic, gold is the ultimate insurance because it is the only asset with no counterparty, i.e no liabilities, so no risk of not being paid back. As said John Pierpont Morgan more than one century ago, “Gold is money, everything else is credit”.
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