Key Takeaways
- Rising interest rates should have provided a challenging environment for gold but that relationship broke down when Russia invaded Ukraine.
- There has been a significant flight of capital into gold by central banks. Politically exposed individuals have also been buying.
- Over 1000 tons was purchased by central banks in 2022 with a similar figure expected for 2023. Turkey was the largest buyer.
- Gold prices should benefit as interest rates trend lower, and its safe haven status should also provide support.
The last couple of years should have been bad for gold from an investment perspective due to rising interest rates. Gold is like a bond without a coupon, a non-interest bearing asset. Yields and interest rates in general are the opportunity cost of holding gold. Higher interest rates should mean lower gold prices.
This chart shows that there was a reasonably close relationship between gold prices and interest rates, but it broke down when Russia invaded Ukraine. I’m plotting the yield on US TIPS, that’s Treasury Inflation Protected Securities, upside down so the line goes down when yields rise the equivalent of UK indexed linked gilts so it’s a genuine real yield. Even as real yields soared the gold price firmed.
Gold prices rising strongly despite higher real rates
Source: Columbia Threadneedle Investments, Bloomberg and Macrobond as of 05/01/2024
The US and EU have frozen some $350bn of Russia’s central bank reserves. The surprising strength of the gold price probably reflects capital flight into gold by central banks and wealthy politically exposed individuals who fear that they may suffer a similar fate at some point in the future. The sanctions on Russia are unprecedented in terms of their breadth and depth. In addition to the central bank, close to 2,000 individuals and entities have had their assets frozen.
These financial sanctions were imposed via central banks in the west together with payment and clearing systems. Euroclear is playing a big, albeit reluctant, role including the interest of billions of dollars in various currencies from Russian assets that have matured and are earning interest on deposit.
Gold is nobody’s liability and though confiscation is still a risk, as a physical asset it can be placed beyond the reach of these sanctions.
Central banks have been buying gold in record amounts: over 1000 tons in 2022 and according to data for the first 9 months they kept up the pace last year.
Turkey has been the largest buyer at a record 542 tonnes with China, India, Singapore, Egypt, Iraq, and gulf states all notable buyers. Of course, these central banks may have other motives for buying more gold. But safety-first considerations must have been a theme for many. And these figures don’t include buying by non central banks.
But where do we go from here? Interest rates are headed lower so that should provide support for the gold price and the capital flight/safety first motive could remain strong. The sanctioned assets have not been confiscated – rather the western governments want them to be used to rebuild Ukraine after the war is over. Once negotiations on a peace deal begin, how this occurs and who controls the spending will be a big component of any deal. As these discussions take place, the vulnerability of conventional financial assets will be highlighted.
There are of course other ways to protect assets from being frozen. I’m sure you’ve all be thinking of bitcoin. Well perhaps, but gold has demonstrated its safety, security, and value for over a thousand years or more. Bitcoin has a long way to go to match that.
Finally, let me emphasise that I’m not giving investment advice here, merely discussing the macro background.
