First, the symmetric decline in inflation across both advanced and developing economies means that central banks are now poised to cut interest rates later this year – with risks being skewed to rate cuts earlier than previously anticipated. The ‘higher for longer’ mantra has not been sustained, due to the rapid declines of both headline and core inflation in the major economies. Lower interest rates reduce the opportunity cost of owning gold, which is a non-yielding asset. There is scope for further modest declines in longer-dated interest rates, which is a benign development for gold given long-standing negative correlations.
Second, slightly weaker USD exchange rates will support further gains for gold. As gold is priced in USD, weaker USD exchange rates lead to modest upside in pricing. Our models indicate that a 1% decline in the US Dollar Index is consistent with an USD 8 per oz rise in the gold price. Assuming that the USD weakens by between 5% and 10% over the course of the year, this will clearly augment prices. Lower front-end interest rates in the US will weigh on the USD, and gold will benefit from this development.
Third, we think that increasing concerns regarding US debt sustainability will benefit gold, both in 2024 and in the years ahead. The US fiscal deficit is in the region of 8% of GDP, which is an extraordinary figure for peacetime. Political dysfunction in the US means that there is little prospect of a plan to reduce fiscal outlays, with the result that the US’ debt-to-GDP ratio will move towards levels of around 130% in the coming years. Similar dynamics are visible in many other advanced economies, and gold may attract increasing asset allocations as a hedge.
Fourth, the recent trend of aggressive central bank gold purchases is likely to continue into 2024. In 2022, central banks purchased a record 1,038 tonnes of physical gold and the 2023 figure will be of a similar magnitude. These large purchases are well above recent long-term averages, and mark a distinct change from previous eras. The main driver of aggressive gold-buying by many emerging market central banks is the desire to reduce their reliance on the USD as the main part of their reserves. In our opinion, this will be a secular trend for emerging market central banks, which currently hold around 80% of global FX reserves. As this reserve diversification continues apace, it will clearly act as a tailwind for gold prices. Aggressive purchases will also limit downside for gold prices. Indeed, we were surprised to see how resilient gold prices were in mid-2023, when US ten-year TIPS yields rose above 2.50%.
Fifth, we believe that gold has entered a new trading regime. Normally, we would expect to see gold trading at lower levels, given the large interest rate rises around the world over the last two years. However, this has not happened. Gold traded with significant resilience, despite higher short- and longer-dated interest rates. The prospect of slightly higher inflation trends in the future, or at least higher than during the pre-pandemic period, likely explains this robust performance. We think that this new era for gold suggests that downside risks are limited.
We expect both retail and institutional investment to be quite strong as we progress into 2024.
We note that investors reduced allocations to gold in 2023, and this was particularly evident in the ETF space. As central banks cut interest rates, we can see both retail and institutional investors increasing asset allocations to the yellow metal.
Finally, we think that ongoing geopolitical risk will be a structural support for gold. US policy has become increasingly insular and less focussed on external developments, with the result that the pre-2016 international policy architecture is no longer functional. It is said that chaos loves a vacuum, and this is clearly plain to see given the rising number of international conflicts. The prospect of a second Trump presidency may result in worsening Sino–US relations, and even US–European relations. We believe that gold will offer a significant hedge on these developments.
Overall, we think that gold has ample scope to move towards our long-term fair value estimate of USD 2,200 per oz in 2024, with risks placed firmly on the upside of this level. Downside risks should be minimal, given aggressive central bank purchases and potentially earlier than expected interest rate cuts.