Gold prices have continued their spectacular run this year, surpassing the US$2,500 mark and becoming one of the best performing assets outside of equities so far in 2024.

Gold is an investment that can provide both a source of return and diversification. The yellow metal has generally tended to perform well when ‘riskier’ assets like stocks fall. So, when events like escalating geopolitical tensions in the Middle East and concerns of an economic slowdown occur, gold has the potential to shine most.

However, there are several other factors that have driven gold’s recent sustained rally, namely:

• A weaker US dollar

• The opportunity cost of holding gold and inflation

• Demand from central banks and investors

In this note, we dig into each of these factors and explore how they have helped the yellow metal reach all-time highs.

A weaker US dollar

As the gold price is most commonly quoted in US dollars (USD), it may come as no surprise that a weaker USD has tended to be positive for gold prices for two reasons:

• It makes gold cheaper for purchasers holding other currencies, and

• Importantly, gold is often viewed as a preferred store of value if there is a debasement or rapid weakening of the world’s reserve currency – i.e., the USD.

As the Fed began raising interest rates in 2022, US cash and bond yields became increasingly attractive. This drove demand for the currency that saw the broad US Dollar Index rally from 95 to over 110. In this environment of USD strength, the gold price fell to around US$1,600, only recovering when demand for USD receded from November 2022.

US interest rate hiking cycle commences in 2022

In the year to date, gold has risen over 20% whilst the US Dollar Index has fallen 1.3%.

For Australian investors, one must be mindful of the relationship between the gold price and the USD when seeking exposure to the yellow metal. Seeking a currency hedged gold exposure provides “pure” exposure to the performance of gold, mitigating the risk of USD weakness eroding returns on an Australian dollar (AUD) basis.

Lower real yields

’Real yield’ is the government bond yield adjusted for expected inflation.

Whilst gold tends to provide a hedge against inflation (i.e., it tends to benefit when inflation rises), there is an opportunity cost of holding a non-income producing asset like gold if interest rates rise.

These competing drivers on the price of gold are captured in the real yield.

In a scenario where government bond yields are falling faster than long run inflation expectations, the difference between the two, the real yield, will fall. As a result, gold becomes relatively more attractive as an asset.

Gold may continue rising as real yields begin falling

The chart above shows how real yields have been trending lower since April 2024, off the back of increasing expectations of US rate cuts, providing a potential tailwind for gold.

Structural demand from central banks and investors

Central banks are one of the largest holders of gold, accounting for around a fifth of all the gold that has been mined throughout history1.

As a reliable store of value, holding gold is important for central banks to diversify their reserves beyond foreign currencies like the USD and US Treasuries. In the wake of the Ukraine invasion, the US showed they were not afraid to ‘weaponise’ the dollar-centric global financial system by imposing crippling sanctions on another nation state. As the world’s reserve currency, the USD gives the United States enormous leverage on the world stage.

In response to this threat, the central banks of countries that wish to remain non-aligned or independent of the US have become huge buyers of gold in recent years. Total reported central bank buying for the first half of 2024 grew to 483 tonnes. Emerging market countries China, India, and Turkey were the three largest net purchasers of gold in Q1 2024.

While Chinese demand for gold jewellery has fallen in response to higher prices and weaker consumer confidence, Chinese investor demand for gold bars and coins has been strong. Access to alternative investment channels is limited in China, so gold is often viewed as the ‘next best’ investment opportunity whilst the property and stock markets continue to deteriorate.

In the first half of the year, Chinese sales in bars and coins increased 46% over the year to 213 tonnes as investors sought gold as a store of value2.

How to access gold in your portfolios

Gold can provide both a source of return and diversification for multi asset portfolios, beyond equities and bonds.

The outlook for the USD gold price remains constructive, with interest rate cuts likely to see both the USD continue to weaken (with no sign from the Fed to prevent this) and real yields declining. Geopolitical uncertainty remains a risk for markets going forward, and structural demand forces from central banks and Chinese households mean gold may remain well supported.

For investors looking to trade gold via ETFs traded on the ASX, it’s worth noting that the weekly correlation between gold returns denominated in USD and changes in the AUD/USD spot exchange rate has been around +0.5 over the five years to 28 August 2024, suggesting that the AUD/USD currency pair has tended to appreciate when the USD price of gold has increased. As a result, investors looking to capture further strength in gold might be doing themselves a disservice by being unhedged.

QAU Gold Bullion ETF – Currency Hedged provides the only currency-hedged exposure to the performance of gold bullion on the ASX.

• By currency hedging, QAU provides investors ‘purer’ exposure to the USD gold price rather than the AUD price of gold.

Investors can also gain currency-hedged exposure to global gold mining companies through MNRS Global Gold Miners ETF – Currency Hedged ).

• Lower interest rates may benefit gold miners’ operations by reducing production costs and lowering the cost of capital across projects.

• Gold mining companies have been a bright spot in a year of poor performance across other areas of the resources sector and can often provide a ‘leveraged’ play on the price of gold with relatively magnified exposure to spot gold price movements (both up and down).

• Gold miners have a relatively fixed revenue base so any rise in the underlying gold price means that, all other things being equal, revenue and profits should be expected to increase – benefiting shareholders of those companies.

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There are risks associated with an investment in QAU and MNRS, including market risk, gold price risk and currency hedging risk for QAU, and market risk, sector risk, international investment risk, mining sector risk and concentration risk for MNRS. Investment value can go up and down. An investment in each Fund should only be considered as a part of a broader portfolio, taking into account your particular circumstances, including your tolerance for risk. For more information on risks and other features of each Fund, please see the Product Disclosure Statement and Target Market Determination, both available on this website.

Sources:

1. https://www.gold.org/goldhub/data/gold-reserves-by-country ↑

2. https://www.chinadaily.com.cn/a/202407/30/WS66a839f4a31095c51c510a33.html ↑