Safe haven: With economic weaknesses, gold prices are likely to go up

Gold this year outperformed all other financial assets, and, indeed, it is one of the best performers in the past several years. Since January 1 it is up around 11 per cent in dollars and over 13 per cent in rupees, partly due to the currency factor. Since January 2024, gold is up over 42 per cent in dollars. 

The metal has a unique reputation as a reliable, traditional hedge against inflation and economic uncertainties. These factors have played their part in driving excellent returns. Central banks last year acquired 1,045 tonnes of gold, marking the third consecutive year of central bank purchases surpassing 1,000 tonnes. Retail investors and metal traders too have been bullish. Indian households have been estimated to hold around 12 per cent of the world’s gold.

  The global economy is weak and supply-chain issues that started with the pandemic have been exacerbated by the Ukraine war and turmoil in West Asia. As a result, there’s been inflation. American President Donald Trump’s tariff policies have added to global uncertainties and imparted an inflationary push.

  This has led to increased demand for safe-haven assets such as gold. There are even rumours of the imposition of a “Trump tariff” on gold, which has led to higher demand with most central banks starting to add to their reserves. Mr Trump has made throwaway remarks suggesting he may be interested in adding to the legendary hoard held by the United States (US) government at Fort Knox.

  There has been informed speculation that the US may decide to revalue its considerable stocks of gold. This could set off a financial earthquake since the US government officially values gold at $42 a troy ounce (about 31.1 grams) whereas the market price is around $2,935/oz.

  Normally a strong dollar (which is the case now) usually leads to a trend of lower gold prices because the metal’s price is dollar-denominated. However, inflation fears and central-bank demand have overcome this technical hurdle and sent prices to record levels despite a strong dollar.

  There could be some interesting implications if the trend continues. Given that the consensus on gold is bullish, and in the absence of other outperforming assets, demand is likely to remain strong. Gold needs to be mined and refined, meaning supply is constricted. Even if new reserves are discovered, they take many years to develop into commercial production. Higher demand could therefore lead to big price spikes even from the current elevated levels. Gold exchange-traded funds and gold-mining stocks are riding the boom — they have seen big inflows correlated to the rise in the primary metal.

  Jewellers, on the one hand, and non-banking financial companies and banks focused on loans against gold, on the other, experience a more nuanced response to rising demand for the metal. For jewellers, it leads to higher demand for their products. However, managing treasury and metal inventories is a delicate business, given that the cost of the metal is rising. Loans against gold also have to be calibrated since they are being disbursed when the collateral is at elevated prices. If there are defaults and the price of gold moderates, lenders may suffer losses.

  Gold has little industrial demand, apart from the demand from the scientific establishment and jewellers. It is not an interest-bearing asset (with the exception of a few gold bonds). Historically therefore, gold prices are inversely related to strong economic performance. If other assets are performing, the drawbacks of gold make it unattractive. However, so long as uncertainties and economic weakness persist, the metal is likely to ride higher.