If you are so happy, why do you buy so much gold?

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Good day. The third quarter earnings season is off to a good start. Until now it has been mainly banks. Market volatility has made trading desks happy; in the retail sector, interest margins are holding up better than expected; and the banking sector is up 6 percent in the last week. Even happier news is that the FT Alphaville Pub Quiz will return to New York on November 12th. Unhedged will be hosting a round – we hope to see you there for some interesting questions and a few drinks! Instructions on how to register are here. Send us an email: robert.armstrong@ft.com and Aiden.reiter@ft.com.

Gold

Much has been written about the gap between consumer confidence, which remains poor, and employment and wages, which are strong. Something similar is happening in the markets: sentiment is increasingly bullish, but gold continues to rise like crazy. This is not a totally anomalous situation, but historically gold has often peaked when investors feel insecure. That is not the case today. Here is a chart of the bull-bear spread from the American Association of Individual Investors sentiment survey (I use the 24-week average because it is a very noisy series) compared to the price of gold. The dotted lines mark the points where gold peaked just as sentiment fell.

It’s not just the AAII survey that shows sentiment is strong. This month’s Bank of America Global Fund Manager Survey showed the biggest jump in sentiment since June 2020, along with a decline in bond and cash allocations. So why is the price of the classic asset where maybe something bad will happen, gold, reaching epic highs?

Unhedged has written several times before about the strangeness of this gold rally. To summarize the main points:

• The price of gold does not appear to respond directly to inflation or money printing. Gold rose as the first emergency fiscal and monetary measures increased the money supply in 2020. But it then deviated as the money supply expanded further and inflation took hold. Only after the Federal Reserve began absorbing liquidity, rates rose, and inflation slowed, that gold really began to rise. Here is the price of gold, M2 money and the CPI price index recalculated to 1 as of January 2020:

• The normal relationship between gold and real interest rates has been broken. The real interest rate is the opportunity cost of owning a non-yielding metal, so when real rates rise, gold tends to fall. Not this time:

• Similarly, gold and the dollar strengthened in tandem for much of this year. Typically, because gold is priced in dollars and is inversely related to US interest rates, they move in opposite directions. The relationship has normalized a bit recently.

• Gold mining stocks are not participating in the rally. The chart below, from James Luke of Schroders, shows the relationship between the price of gold and the price of the VanEck Gold Miners ETF (the green line). Miners are very cheap compared to metal. The blue line is the gold mining industry’s current “all-in sustaining cost margin” to produce one ounce of gold. The margin is actually very high. A strange combination, and one that suggests that investors in gold mines (to the extent there are any left) don’t think gold at $2,700 will last.

To make sense of these oddities, one might ask: who buys all the gold? In particular, who has been buying it since it surpassed $2,100, the level at which many experts thought demand from price-sensitive buyers would dry up?

The first candidate is the central banks. They did it significantly increase the portion of its foreign exchange reserves held in gold in 2022 and 2023. But, according to the World Gold Council demand According to the report, central bank demand will remain practically stable in the first half of 2024.

Investment demand (bullion, coins, ETFs) also appears to be flat compared to last year. While gold ETF holdings are rising a bit, they are still lower than last year at this time. Here’s a chart from RBC’s Josh Wolfson:

The jewelry lawsuit doesn’t seem to be the culprit either. Demand for Chinese and Indian jewelry, an important part of the global picture, has fallen dramatically as prices have risen and the Chinese economy has slowed, according to the WGC.

Who is driving the price then? I’ve heard several theories: secret-buying sovereign wealth funds and price-chasing hedge funds are the most popular. It is certainly true that momentum-driven quant funds will chase any price with a strong uptrend.

Whatever the marginal buyer, the move from $2,000 to $2,700, if it holds in any significant way in the coming months, suggests that gold may be becoming a slightly different type of asset.

Of course, it could be that gold is responding to the fact that there are wars in Europe and the Middle East, as well as acute electoral uncertainty in the United States. In fact, geopolitical concerns are almost certainly part of the story. But if that were the whole story, shouldn’t stocks be falling and bond volatility rising?

In a world awash in liquidity, gold may have become another asset that investors buy when they decide they have too much cash on their balance sheets. If something like this is true, it would suggest that gold will act more as a risk asset and less as a hedge in the future.

A quite different explanation is that gold, rather than responding to short- or medium-term movements in rates, inflation and money supply, is making an adjustment to the expectation that we are in a new, more fiscally wasteful regime, where the neutral rate The interest rate is higher, central banks are under more pressure and inflationary incidents are more common. In such a world, gold might deserve a slightly larger place in the optimal portfolio.

As something of a gold skeptic, I have a hard time accepting any of these hypotheses. But I would love to hear readers’ opinions.

a good read

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