6 Factors Driving Demand for Gold

Before the price breakout in June of this year, gold traded in a range between $1,050 and $1,370 an ounce for over five years. Since June, the yellow metal has soared to six-year highs against the US dollar and record highs against other major currencies. A number of interrelated factors suggest that higher gold prices could be coming. These include a shift towards dovish central bank policy, a sharp drop in bond yields, geopolitical instability, financial market uncertainty and fears over a global recession.

The US/China Trade War

The global markets have been shaken by the ongoing trade war between the US and China. Stocks have suffered sharp selloffs and bond yields have fallen to fresh lows. The trade war which began in March of 2018 was initially more supportive of the US dollar and gold prices actually fell substantially between March and August of 2018. However, fears of a global recession triggered by the trade conflict have increasing led investors to gold as a safe-haven.

Negative Bond Yields

Roughly $15 trillion of government bonds worldwide now trade at negative yields, representing 25% of the global government bond market, according to Deutsche Bank. Countries including Japan, Switzerland, France and Germany have 10-year-bonds with negative yields. In Germany, the 30-year government bond recently went negative for the first time ever. The dramatic fall in bond yields has fueled expectations that central banks are likely to engage in further monetary easing to stimulate economic growth. When bonds offer zero or negative interest rates, alternative non-interest yielding assets such as gold naturally become more appealing.

Central Banks Buying Gold

A major factor in the rise of gold prices has been the increasing purchases by global central banks. According to the World Gold Council, central banks bought 145.5 metric tons of gold in the first quarter of 2019, the strongest level since 2013. Both Russia and China have tripled their gold reserves in recent years. The People’s Bank of China increased its gold reserves by 74 tons in the six months through May while the Russian central bank purchased 96 tons in the first half of 2019. The stockpiling of gold by America’s geopolitical rivals is widely seen as a move to diversify away from the US dollar and potentially undermine the predominance of the greenback.

Expectations for Dovish Monetary Policy

In July the Federal Reserve lowered interest rates by a quarter point, marking the first rate cut in 11 years. Analysts widely expect that the Federal Reserve Chairman Jerome Powell will cut interest rates again in September. The shift towards easing among central banks across the globe is a primary factor in driving gold prices higher.

Gold was boosted in July by comments from Ray Dalio of Bridgewater Associates. Touching on the effect of lower interest rates, the founder of the world’s largest hedge fund stated on LinkedIn:

“ those (investments) that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold.”

He added:

“I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”

Geopolitical Risks

Beyond the trade war, several areas threaten geopolitical stability and support the appeal of safe-havens such as gold. The turmoil over Brexit in the United Kingdom continues to intensify. Prime Minister Boris Johnson has stated that he is prepared to leave the EU with or without a deal, despite warnings of dire consequences from a disorderly exit. Tensions are rising in the Middle East, with the latest US sanctions imposed on Iran. Finally, the lead up to the highly contentious US Presidential election taking place in November 2020 could roil the markets.

Global Recession Fears

In April, the International Monetary Fund (IMF) cut its 2019 outlook for global growth to the lowest level since 2009, partly due to signals that higher tariffs were hurting trade. In July, the IMF cut its growth forecasts for the global economy for both 2019 and 2020, citing an escalation of trade tensions.

The Bottom Line

With rising concerns over global recession and bond yields sinking, the markets now intently look to the Federal Reserve annual meeting in Jackson Hole for signals on interest rate policy. The meeting is the first time Federal Reserve Chairman Jerome Powell will speak since the July FOMC meeting. A quarter-point rate cut is widely expected in September and investors will be looking for clues as to whether a half-point cut is in the cards.