"Press for Gold thoughts"

Before the kids, there have been a few times when I’ve flown out to Vegas for a long weekend, hit the tables and enjoyed some very good restaurants. At the tables I enjoyed the banter with the dealers and other customers, and after being asked what I did for a living, often the conversation ended up on precious metals and specifically silver and gold. So allow me to reminisce this weekend, and tell you a little about what has caught my attention recently when it comes to gold.

For many years US real yields were all you needed to figure out the gold price – the theory being that gold is an asset without a yield so investors find it more attractive in times of low and negative real interest rates and vice versa. However, in the last couple of years that relationship has broken down. In the chart below I have inverted 10-year real yields to better illustrate the recent disconnect; with real yields moving higher in recent quarters, we would normally associate that with a weaker gold price but instead we are breaking out to new highs here. What is going on and how should we think about the path forward?

I believe increased central bank demand, investment demand, supply-side dynamics, and the geopolitical and fiscal backdrop are some of the key areas that have been supportive and may remain so for the coming quarters.

Central Bank demand

2022 and 2023 have seen a resurgence in demand from reserve managers, with 2022 the highest level of purchases since 1968. There are various theories around the reasons for this but it is notable that countries less geopolitically aligned to the US have been the largest gold buyers of late.

?According to the 2024 Central Bank Gold Reserves survey, conducted over February-April 2024, 29% of central bank respondents plan to increase their gold reserves in the next twelve months, the highest level observed since the World Gold Council began this survey in 2018. Tellingly, when asked how they expected global central bank gold holdings to change over the next 12 months, through time we see an increasing proportion of respondents expect this to increase. Reasons cited are a desire to rebalance to a more preferred strategic level of gold holdings, domestic gold production, and financial market concerns including higher crisis risks and rising inflation. The PBoC in particular is notably behind its 2023 pace of buying, which could provide support on any pullback.

Investment Demand

Citi’s Commodity research team published a note earlier this month which uses a physical investment-led framework to explain annual price movements. It suggests the relationship between gold prices and total private and public investment demand as a share of mine supply has been remarkably strong over the past 55 years on an annual basis, as well as over the past 25 years on a quarterly basis. From 3Q22 to 1Q24 they find that gold investment demand from China and Central banks has averaged more than 70% of mine supply, up sharply from only 25% of mine supply over the 3 years prior. They expect gold investment demand to rise to absorb almost all mine supply over the next 12-18 months, underpinning a move higher to $2700-3000/oz in gold during 2025.

While net length in gold from speculators has increased, we are still not at the highs, supporting the notion there is room to run.

ETF flows have been a headwind for several months now, but have just inflected more positively.

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Supply-side Dynamics

Higher prices should naturally incentivise increased supply, but there have been structural challenges facing producers such as lower ore grades, falling mine reserve life, rising environmental constraints and regulation, less new discoveries, resource nationalism, higher costs, more adverse weather conditions and so on.

What is even more surprising is that scrap, the second largest contributor to gold supply, has not seen any material increase in the face of higher prices. Some point to heavy recycling in the post GFC era when financial stress triggered a significant rise in recycling, which has meaningfully reduced the available stockpile for recycling.

Geopolitical Risks and Fiscal deficits

Various academic work suggests holding precious metals within a diversified portfolio lowers the impact of geopolitical risk and clearly we have been through a period where this is rising. Given US elections and the possible combination of Trump/Vance in the White House, as well as ongoing US-China trade tensions under the current administration, these seem unlikely to fade in the near term.

Maybe one of the most compelling long-term reasons I find to own some gold in a portfolio, are to protect again a large deterioration in the US fiscal deficit and/or the day when we get some melt-down in the US Treasury market. The Congressional Budget Office forecasts the federal budget deficit to keep climbing and hit 122% of GDP in 10 years from the 99% level today. Recent Presidential terms have led to more cyclically expansionary policy than in the past, and whatever the outcome of US elections it feels like we will continue down this path. Government interest payments will likely continue to soar over time so will markets keep supporting the status quo indefinitely? The structure and liquidity of the Treasury market itself is something to monitor – it has doubled in size every seven years since 2001, yet the capacity of dealers and banks to warehouse Treasuries has not matched that growth given banking regulation, and arguably the marginal buyer is a lot more price sensitive now than in the past.

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Bernie’s weekend eats – Bob Bob Ricard City?

When I think of a bling restaurant setting, in keeping with the subject of gold, it’s hard to look further than Bob Bob Ricard City. Every table comes with a “Press for Champagne” button (something you never thought you needed in your life until after the week we’ve just been through in markets perhaps!), each one a booth set within a sparkling interior inspired by the Royal Yacht Britannia and modern day super yachts, and connected to a wine cellar with multiple large formats ranging from magnums to methuselahs. The food is a selection of British and French classics with a Russian twist. I recommend starting with the truffle potato and mushroom vareniki or the lobster pelmeni, washed down with a shot of super smooth vodka, and from the mains I love the chicken pie or the Beef Wellington. Maybe to your surprise, the wine list offers incredible value, as they cap the mark-up on fine wine to ￡75 however expensive the bottle, so you can end up buying bottles here at the same price as retail. With gorgeous private rooms, this is a great place for a special occasion like a birthday, often finished off with the “Chocolate Glory” – a gold embossed sphere that melts under the heat of warm chocolate sauce poured tableside.