Sticky inflation boosts gold

Inflation in the driver’s seat for now

Changing expectations about the US Federal Reserve’s (Fed’s) monetary policy path was the major driver of gold prices in 2023. Gold found support as the odds of Fed rate cuts increased and vice versa. This year, however, we are starting to see a decoupling between Fed path expectations and gold. The odds and number of cuts expected in 2024 have been reduced in the first few months of the year, yet gold’s price keeps hitting new highs. We think this may be driven by renewed concerns around inflation.

In April, for example, an inline jobs report for March, combined with higher-than-expected CPI figures that showed an uptick in inflation in the US (3.5% year-over-year in March versus 3.2% in February), translated to US consumer sentiment declining by more than forecast and inflation expectations increasing. The University of Michigan’s preliminary April Consumer Sentiment Index dropped to 77.9 from 79.4 in the previous month and compared to the median estimate by economists of 79. The sentiment index implied consumers estimated prices will climb at an annual rate of 3.1% year-on-year, up from the 2.9% expected a month earlier and the highest so far this year. Later in the month, Q1 2024 preliminary annualised quarter-over-quarter GDP came in at 1.6%, well below expectations of 2.5%, while the Core Personal Consumption Expenditures Index was up 2.8% year-over-year versus estimates of 2.7%.

Expectations for slower economic growth and higher inflation are generally supportive of gold prices. A pullback of the broader equity markets, like we had in April, and rising global geopolitical tensions provide further support, as investors turn to gold as a safe-haven and portfolio hedge/diversifier.

Western investment demand still absent

Yet, western investors appear mostly absent in the gold markets today, with recent strength fueled by central banks, and demand out of Asia, primarily China. The World Gold council reported that global gold bullion backed ETFs lost 114 tons during Q1 2024, a 4% decline in total holdings¹. Interestingly, while North America and Europe saw ETF outflows, Asian listed funds had inflows during the quarter, the fourth consecutive quarter of inflows.

Chart 1: Gold ETF Flows and Assets

Source: World Gold Council. Data as of March 31, 2024.

Investment demand, the main driver of gold prices historically, has been in decline during this last gold rally. We believe the return of Western investment demand supported by increased risks to the US economy and a deeper correction of the equity markets, has the potential to drive gold prices higher. If we use a simple calculation based on historical data and ETF holdings we can provide an estimate of future potential gains. The last time gold bullion backed ETF holdings were at around current levels was in late 2019. By late 2020, about a year later, these holdings had reached peak levels and the gold price had risen over US$400 per ounce. Therefore, if ETF holdings were to return to their historical peak (reached in 2020) and based on the same historical correlation between these holdings and the gold price during that period, it is not unreasonable to assume that gold could climb another US$400 per ounce from present levels. That would take the gold price to approximately US$2,700 per ounce, based on April’s closing price, and to about US$2,800 based on its recent high. Coincidently, that would put gold right around the inflation adjusted price reached in January 1980, when gold traded at an intra-month high of US$850 per ounce (equivalent to a CPI-adjusted $2,819 per ounce as of end of Q1 2024).  

Chart 2: Gold Price – Nominal vs. CPI-Adjusted

Source: VanEck, Bloomberg. Data as of March 31, 2024. Note: January 1980’s intra-month high of $815 (in nominal terms) would be equal to approximately $2,819 in today’s (2024) dollars.

Of course, that would require the continued support of the current drivers of demand—particularly the official sector. Central banks have emerged as an important driver of gold prices over the last two years. They appear to be on a longer-term trend of gold buying. Central banks net purchases of gold in Q1 2024 (290 tonnes) represented the highest quarterly figure on record since 2000, and was 69% higher than the five-year quarterly average of 171 tonnes, demonstrating the banks’ accelerating appetite for gold despite the metal’s strong rally during the period². However, it’s a little too early to assess how price sensitive these purchases may be and whether further gains in the gold price could dampen demand from this sector. Gold has had an impressive rally so far this year. We wouldn’t be surprised to see gold pulling back a bit and entering a period of consolidation at a lower level from present, though still well above US$2,000, before embarking on the next leg of its rally.

Miners gain back ground

Talking about peaks…the gold miners have recovered some ground over the last couple of months, but they are still nowhere near their all-time highs. After a strong March, the NYSE Arca Gold Miners Index continued to significantly outperform gold in the month of April, up 6.57%.  We still think there may still be plenty of runway for gold stocks as they reclaim their role as a leveraged play on the gold price. Our expectations of a sector re-rating are not only supported by continued strength in the gold price, but also anchored to generally solid company fundamentals. We are encouraged by financial and operating results reported by gold companies for Q1 2024, which seem to be mostly in-line with expectations for the group so far.

Chart 3 and 4: Relative Price Ratio – Gold Miners vs. Gold (Sep-2011 and Aug-2020 to Apr-2024)

Source: FactSet, Bloomberg, VanEck. Data as of April 2024.

¹World Gold Council - Gold Demand Trends Q1 2024

²World Gold Council - Gold Demand Trends Q1 2024 - Central banks