Why gold prices are hitting record highs

Gold prices have hit an all-time high as markets worldwide are rallying in anticipation of the US central bank slashing the benchmark interest rate in June.

The spot-market gold rate crossed $2,300 per ounce on April 3 before dropping a little in the initial trading hours on Thursday.

This would mean bad news for the world’s biggest gold consumers China and India – the world’s second and fifth biggest economies – which drive the global demand for the yellow metal.

The Chinese bought 630 tonnes of gold in 2023, while India's consumption was pegged at just over 562 tonnes.

Gold is integral to weddings in the Indian sub-continent, where the summer wedding season is in full swing.

The price of gold usually has a negative correlation with the ‘real’ interest rate, which is the nominal interest rate less inflation. When real interest rates are low, other asset classes become less attractive than gold.

The cost of borrowing rose quickly in the United States in the last couple of years as the Federal Reserve tried to fight inflation, which surged to a 40-year high.

However, the key interest rate has been kept within the range of 5.25 percent and 5.5 percent for almost a year now–something analysts expect to change in June. The US Federal Reserve is likely to cut interest rates this year, Chair Jerome Powell said on April 3.

The gold price has rallied almost 26 percent since a low of $1,820 per ounce on October 5, 2023.

According to Joni Teves, a precious metals analyst at financial services firm UBS, the expectation of falling real interest rates is an “important driver” for the bullish outlook on gold.

“As long as the Fed stays dovish, there is a risk of even larger declines in real rates should inflation surprise on the upside,” he said.

J.P. Morgan Research told investors on April 3 that it remains “structurally bullish” on the precious metal over the next year.

“This is as investors increasingly seek out the safe-haven asset against a backdrop of economic and geopolitical uncertainty,” said Gregory Shearer, head of base and precious metals strategy at J.P. Morgan.

He said the expectation of a rate cut by the Federal Reserve will be reinforced by continued moderation in inflation and jobs data over the coming months.

In turn, it will trigger the next wave of inflows from discretionary and exchange-traded funds, further pushing gold prices up.

The second reason for the bullish trend in gold prices is growing uncertainty on the geopolitical front.

Israel’s brutal war on Gaza is now spreading to the wider Middle East. This has pushed investors to park their wealth in safe havens like gold, which has maintained its status as a store of value through war and economic destruction for thousands of years.

Another key reason for rising gold prices is the ‘voracious demand’ for gold by central banks worldwide.

Data from the World Gold Council shows that the People’s Bank of China (PBoC) purchased 225 tonnes of gold in 2023, bringing its gold reserves to 2,235 tonnes.

Analysts attribute the hefty gold buying by China to the increased economic and financial uncertainty and geopolitical tension.

“It is in principle possible that China would especially like to reduce its reliance on dollar-denominated reserves, given the increase in tension with the United States,” Louis Kuijs, chief economist for Asia Pacific at S&P Global Ratings, told TRT World in a recent interview.

Central banks usually prefer to hold the largest part of their foreign exchange reserves in the US currency because it’s most liquid and backed by the US government.

But the bulk purchases by China’s central bank point to the possibility of the economic juggernaut steering away slowly from the dollar-denominated reserves.

After all, keeping the entirety of foreign exchange reserves in US dollars can make a country vulnerable to the US. A case in point is Russia, which has had its central bank reserves estimated to be between $300 billion and $415 billion blocked by US sanctions in response to Moscow's war on Ukraine.

While there’s much optimism about the rally in gold prices to continue, some analysts have warned that the surge “looks overdone”.

The cautious approach is based on the assumption that the Federal Reserve may slash the interest rate more slowly than expected if inflation doesn’t come down immediately.

“The US economy is surprising with its strong performance, which would make a first interest rate cut in June less likely and thus weigh on the gold price,” a report in the Financial Times quoted Alexander Zumpfe, senior precious metals trader at refinery Heraeus, as saying.