The rise in the gold price this spring was undoubtedly spectacular. In just a few weeks, gold prices rose by almost 20% in USD terms, with a gain of 21.7% for the first half of the year. Since December 2023, gold recorded numerous new all-time highs and has easily surpassed the US$2,500 mark. The showdown in the gold price that we predicted in the In Gold We Trust report 2023 has come to pass.
What is remarkable is that all of this is happening in an environment in which, according to the previous playbook for gold investors, the gold price should actually have fallen. The collapse of the correlation between the gold price and real interest rates raises many questions. In the old paradigm, it was unthinkable that the gold price would trend firmer during a phase of sharply rising real interest rates. Gold investors are now entering terra incognita.
Traditional correlations are breaking down
In addition to the high negative correlation between the gold price and US real interest rates, the once strong link between investor demand from the West and the gold price has dissolved in recent quarters. In view of gold’s record run, one would have expected ETFs to register record inflows. First, things turn out differently, and second, they unfold contrary to expectations: From April 2022 to June 2024, there was a net outflow of almost 780t or 20% from gold ETFs. According to the old gold playbook, gold should be at around US$1,700 in view of the fall in ETF holdings.
Consequently, a key element of the new gold playbook is that the Western financial investor is no longer the marginal buyer or seller of gold. The significant demand from central banks and private Asian investors is the main reason why the price of gold has been able to thrive even in an environment of rising real interest rates.
A reduction in gold ETF holdings when real interest rates rise is certainly a rational decision from the point of view of the players in the West, provided they assume that:
- They are not exposed to increased counterparty risks and therefore have no need for a default-proof asset
- Real interest rates will remain positive in the future and a second wave of inflation will not occur
- They suffer opportunity costs if they underweight traditional asset classes such as equities and bonds or even “concrete gold” (=real estate) at the expense of gold
In our opinion, all three assumptions should be questioned – and that sooner rather than later.
The marginal actor on the gold market moves from West to East
The global East, on the other hand, is becoming increasingly important This is hardly surprising given that the West’s share of global GDP continues to decline due to weakening growth and an ageing population.
In addition, many Asian countries have a historical affinity for gold. India and the Gulf States in particular are worth mentioning, but China is also increasingly discovering its preference for gold. Here are some figures: Demand for gold jewellery totaled 2,092t in 2023. China accounted for 630t, India for 562t, and the Middle East for 171t. Together, this amounts to almost two thirds of total demand. Of the almost 1,200t of gold bars and coins that were in demand in 2023, almost half went to China (279t), India (185t), and the Middle East (114t).
Gold is also benefiting from other developments. China is discovering gold as an alternative retirement provision precisely because of the structural problems on the real estate market. Gold in the form of beans is currently very popular, especially among China’s youth. The strong demand for gold from Asian central banks is another pillar of this epochal change. These changes are also the reason why certain certainties such as the close correlation between the gold price and US real interest rates are disintegrating.
Central banks are becoming increasingly important for gold demand
Central bank demand accelerated significantly in the wake of the freezing of Russian currency reserves immediately after the outbreak of the war in Ukraine. As a result, central bank demand for gold reached a new record high of over 1,000t in 2022, which was only narrowly missed in 2023. Q1/2024 was then the strongest first quarter since records began. It is therefore hardly surprising that the share of central bank demand in total gold demand has increased significantly: From 2011 to 2021, the share of central banks fluctuated around the 10% mark, whereas in 2022 and 2023 the share amounted to almost 25%.
The deep distortions triggered by the sanctioning of Russian currency reserves will keep central bank demand for gold high for some time to come. This is also shown by the recently published World Gold Survey 2024 by the World Gold Council (WGC).
According to the survey, the 70 central banks included in the survey assume that central bank gold reserves will continue to grow. Geopolitical instability is the third most important reason for central banks in their investment decisions. And geopolitical instability will undoubtedly be with us for some time to come.
The new 60/40 portfolio
The investment environment for gold investors has fundamentally changed. It is therefore also time to adapt the traditional 60/40 portfolio to these new realities.
Aside from gold, we also see other alternative asset classes such as commodities and Bitcoin as beneficiaries of the new gold playbook. We are therefore convinced that these two asset classes are indispensable in a portfolio that is to be prepared for the new playbook. A suitable portfolio consists of 60% equities and bonds and 40% alternative asset classes.
Our interpretation of the new 60/40 portfolio for long-term investors provides for the following allocation:
This marks a clear departure from traditional 60/40 portfolios. Of course, this positioning is not a rule set in stone, but rather a guideline that is based on current market conditions and will evolve with time and changes in the currency environment. The new playbook applies as long as we are in a period of currency instability, characterized by vast debt burdens and above-average inflation volatility. In other words, until we return to an environment with a stable hard currency – be it a sovereign hard currency or a gold/Bitcoin standard – a higher proportion of hard currencies seems necessary.
