The allure of gold has captivated humanity for centuries, morphing throughout history from a symbol of wealth and power to a modern-day asset class embraced by investors globallyIn contemporary financial markets, gold continues to hold significant relevance, characterized by its long-standing capacity to deliver attractive returns over the long termThis precious metal has offered an annualized appreciation of around 8% over the past two decades, highlighting its potential as a reliable component within diversified portfolios.

Despite its historical resilience, gold pricing is notorious for its volatilityNotably, the period from 2011 to 2015 saw the precious metal's value plunge by approximately 40%. It only regained its footing following a robust surge that commenced in 2020, translating to a distinct rebound for investors who stayed the course during challenging timesCurrently, as we approach the end of 2023, gold has been witnessing an unprecedented surge, reaching historical peaks that further entrench its status as a coveted asset.

Looking forward to 2025, predictions are optimistic, with expectations that the price of gold could soar to an estimated $3,150 per ounce by year's end

Advertisements

A host of macroeconomic variables, as well as supply and demand dynamics, establish the theater in which gold prices are set to flourishFor investors constructing portfolios meant to weather cyclical downturns, understanding the unique characteristics and advantages of gold is imperative.

What are the driving forces behind gold’s price movements? Here’s an exploration of three primary factors:

1. U.SDollar Exchange Rates

Gold is intrinsically tied to the U.Sdollar, as it is priced in this currencyA common observation is that gold prices typically exhibit an inverse relationship with the value of the dollarWhen the dollar weakens, gold becomes more affordable for individuals holding other currencies, often leading to increased demandConversely, when the dollar strengthens, gold's appeal diminishesNonetheless, this relationship is influenced by multiple factors and is not always consistent

Advertisements

For instance, between 2012 and 2013, gold experienced an 18% drop despite the dollar remaining relatively stable, reflecting less than a 1% increase.

As we envisage the future, we anticipate that the dollar environment could still favor gold pricesFollowing November, the dollar underwent robust appreciation, and its current level mirrors heightened market expectations regarding inflation and interest ratesAlthough we believe the dollar will maintain its strength going forward, significant further increases in value appear less feasibleIn fact, the dollar’s current trading price exceeds its fair value, estimated based on interest rate differentials and long-term averages, by a margin of 10-15%. Over the long haul, the dollar may revert to a mean value, and we expect this overvaluation to correct, albeit not immediately, as it stands supported by the U.S.'s comparatively strong economic growth against other principal economies.

2. Changes in Real Yield Rates

Gold’s pricing has historically demonstrated a negative correlation with real yield rates—adjusted for inflation

Advertisements

Not producing any interest income, gold effectively presents an opportunity cost of holding assets that do yield returnsAs real yields decline, gold becomes increasingly attractive compared to interest-earning assets like cash and fixed-income securitiesThis dynamic largely accounts for the notable rise in gold prices since the 1990s, during which time real yields have displayed a structural downward trendSignificant periods of appreciation in gold prices, such as from 2008 to 2012 and 2019 to 2021, correlate strongly with the impact of global quantitative easing and zero interest rate policies that drove yields into negative territory.

However, a remarkable decoupling in the relationship between gold prices and real yields has been evident over the last two yearsNotably, when the Federal Reserve embarked on an unprecedented tightening cycle in early 2022, aiming to address stubbornly high inflation amid global supply chain crises, real yield rates experienced a dramatic surge to their highest levels post-2008 financial crisis

• Diversifying Global Trade Networks
• 2024 Year-End Decline in U.S. Stocks
• Collaboration Key to EU Reindustrialization
• Strengthening Economic Resilience for Recovery and Growth
• Over 26 Billion Yuan Net Inflow into Stock ETFs Last Week

During 2022, the 10-year U.Sreal yield climbed by an astonishing 250 basis points, with further increases of 20 basis points in 2023. Yet against this backdrop of rising yields, gold displayed remarkable resilience, maintaining essentially flat returns in 2022 and achieving a robust 13% gain in 2023, culminating in a historic price of $2,068 per ounce by year-end.

Could this decoupling be permanent? We maintain that the shift is likely transitory and may revert in the futureGold has continued to react to changes in real yields, albeit asymmetrically; price dips occur less sharply as yields rise, while more significant upticks are observed when yields fallThe recently altered supply-demand dynamics primarily drive this phenomenon.

3. Supply and Demand Dynamics

At the core of any commodity's pricing lies the balance of supply and demandWhile various macroeconomic factors impact gold prices, supply-demand dynamics remain crucial

Global extraction and recycling rates of gold have maintained relative stability over the years, rendering fluctuations in demand particularly influential on price movementsMoreover, the unique financial traits of gold differentiate its demand profiles from other commodities, predominantly stemming from three sources: industrial use, investment, and central bank reserves.

Within industrial demand, jewelry manufacturing constitutes roughly 50% of annual gold consumptionGold jewelry is revered as a timeless symbol of beauty, value, and status—especially in Asia, where demand surges, particularly from nations like India and ChinaTechnological applications, internationally, account for around 10% of gold demand, utilized in industries such as electronics, dentistry, and aerospace.

Investment and reserve management, albeit smaller in share relative to overall consumption, significantly influence gold prices

In recent years, the effect of currency reserve managers, like central banks, on gold dynamics has become increasingly pronounced.

Both retail and institutional investors acknowledge gold as a vital portfolio componentInvestments can be made through various avenues, including exchange-traded funds (ETFs), futures, options, or structured notesDifferent considerations lead some investors toward physical gold holdings, such as bullion, coins, and ownership certification tied to specifically numbered bars.

Since the introduction of gold ETFs in 2004, retail investors have gradually accumulated significant positions, particularly during the global lockdowns triggered by the COVID-19 pandemic in 2020, when records were shatteredAlthough gold ETF holdings have begun to wane since this initial surge, they have now settled to pre-pandemic levelsDemand for gold ETFs among retail investors typically aligns with anxieties surrounding inflation, conflict, or crises, as well as relative interest rates

Retail investors usually exhibit a shorter-term investment horizon, but their activities can substantially influence price movementsInstitutional investors, in contrast, can afford a much more extended investment timeline—demonstrating a clear preference for holding tangible gold assets across decades, exemplified by pension funds and foundations.

Hedge funds and commodity trading advisors adopt more speculative investment strategies, potentially exerting long-term effects on price trajectories.

Our Outlook on Gold

In the upcoming 12 months, we uphold a positive outlook for goldThe demand landscape remains robust; driven by structural trends, central banks are likely to continue purchasing gold, while a decrease in cash rates could herald sustained inflows from retail investors in the coming yearDespite uncertainties surrounding inflation, the Federal Reserve is positioned to lower policy rates from their current highly restrictive levels