Central Banks Fuel Gold Rally Through Uncertain Times

• Gold demand is up 5% year-to-date, on pace to set a new record for central bank purchasing
• Retail investment strong, particularly in emerging markets like India and Türkiye
• Jewelry demand holding up well despite high prices and economic weakness in some regions
• Headwinds from monetary policy and strong dollar keeping prices rangebound around $1,800
• Supply is on track for a record year with miners increasing production despite rising costs

Gold has long served as a safe haven asset during times of market turbulence and economic uncertainty. This year has seen no shortage of geopolitical tensions, high inflation, and financial market volatility. In this context, demand for gold as an investment and wealth preservation vehicle remains robust in 2023. Total gold demand is up 5% year-to-date, according to the World Gold Council’s Q3 Gold Demand Trends report. What is driving this demand, and why are central banks and retail investors piling into gold when asset prices are weakening across the board?

Central Bank Purchasing Powering Ahead

The standout story in gold demand continues to come from central banks, particularly in emerging and developing nations. Central bank net purchases hit a new all-time high in 2022 at nearly 1,100 tonnes. This year is on pace for another record, with over 800 tonnes acquired in the first three quarters putting 2023 central bank demand on track to eclipse last year.

Central bank buying has been an uninterrupted trend for the past 14 years. Increased allocation to gold reserves is a way to stabilize balance sheets in the face of considerable geopolitical and economic uncertainty. With global growth forecasts being repeatedly downgraded, central banks seem to be positioning for leaner times by diversifying away from assets like government bonds and adding a wealth preservation asset like gold.

Singapore and Türkiye stand out as 2 central banks that have been particularly aggressive buyers of gold this year. While seeking safe haven, there are also currency stabilization motives at play. It's a very clever move by the central bank to do that - an age-old trade of gold playing a role as a fiat currency devalues.

With the potential for further shocks to emerging market currencies as the Fed continues tightening policy, central banks seem likely to maintain their strong pace of gold purchases.

Investment Demand Diverging Between Institutions and Retail

On the investment side, demand trends have diverged between institutional and retail investors this year. Gold-backed ETFs, predominantly held by asset managers and hedge funds in developed markets, saw significant outflows as managers took profits and rebalanced portfolios. With interest rates rising, the opportunity cost of holding gold has increased. The dollar strength that often accompanies Fed tightening cycles also pressures gold prices.

However, retail investment demand has held up well. Coins and bars saw inflows increase 56% year-to-date. Particularly strong retail demand came from India and China ahead of festival seasons. These buyers are less reactive to short-term price moves and value gold’s accessible liquidity and wealth preservation characteristics.

The diverging trends between institutional and retail investment demand result from access to different types of products but also differing motivations. Western institutional investors treat gold more as a financial asset, while emerging market retail buyers view it as real wealth protection.

-When wealth creation is happening, people are getting wealthier and spending on things like jewelry, watches, necklaces, etc but also, you have this other dynamic – the financial aspect of gold where it behaves like money.

In times of economic turbulence, jewelry buying may fade but investment demand increases as individuals seek to preserve their wealth.

Jewelry Demand Defying Gravity

Despite persistently high prices dampening discretionary spending in many parts of the world, global jewelry demand has also held up well in 2023. It makes up around 45% of total demand. Overall jewelry demand is up 2% year-to-date, tracking close to 2022’s full year numbers.

The resilience has been driven by India, where improved monsoon rains and strong festival season gold purchases boosted demand. This helped offset weakness in China where lockdowns hurt spending. The festival effect shows the unique cultural role gold jewelry still plays in parts of the world during holidays and celebrations. Even amidst high inflation, consumers will prioritize these gold purchases.

If prices rise further towards $2,000, however, economics may win out over culture. But for now, hearty retail investment flows paired with sustained jewelry demand continue to provide a floor for prices.

Supply Racing to Meet Demand

What about the supply side? Mine production is actually on pace for a new record in 2023 despite cost pressures facing miners from energy, labor and equipment expenses. Recycling has also picked up, particularly in South Asia where consumers are selling back their gold jewelry to take advantage of high prices.

This boost in scrap supply and mining output has helped balance rising investment and jewelry demand. It seems miners are keen to maximize production with prices elevated at around $1,800. However, if prices spike much higher on a structural rise in demand, it remains to be seen whether supply can keep up. It takes years to develop new high-quality mines.

Key Takeaways

Gold demand has shown impressive resilience in 2023 led by record central bank purchases, maintained retail investment interest globally, and surprisingly firm jewelry consumption. Strong supply growth is helping meet this demand and keeping prices rangebound for now.

However, heightened geopolitical uncertainties, the potential for further emerging market financial crises as the Fed keeps tightening, and high inflation eating into global growth all provide the backdrop supportive of continued gold accumulation.

Both central banks and retail investors are recognizing gold’s wealth preservation appeal during times of market dysfunction and economic stagnation. Until we see a sustained recovery take hold globally, gold should remain an attractive diversifier for portfolios seeking durable assets amidst expansive risks unseen since the 1970s.

The Investment Thesis for Gold

Key reasons to invest in gold

• Diversification: low to negative correlation to stocks and bonds
• Inflation hedge: historical record of holding value
• Crisis hedge: counter-cyclical safe haven asset
• High liquidity: ease of exchange for other assets
• Central bank demand: validation of wealth preservation appeal

Suggested allocation

• 5-10% of the portfolio as a strategic allocation
• Rebalance periodically to maintain target weight
• Focus on physical gold (bars, coins) or allocated accounts over ETFs‍
• Take advantage of range-bound pricing of around $1,800 to accumulate a position. The macro environment remains supportive with limited downside risk.

The key macro theme driving gold demand is a general rise in global uncertainty - geopolitical tensions, growth struggles in China, and financial market fragility. In this climate, central banks and individual investors alike are reassessing the vulnerability of mainstream assets like bonds and diversifying into gold. Its counter-cyclical, crisis-hedging properties make it a potent portfolio stabilizer during periods of elevated risk.

When people start to get concerned or looking to mitigate and moderate their market risk...they allocate it to market uncertainty.

We seem likely to face an extended timeframe of market uncertainty and mediocre global growth. That spells an opportunity for gold to consolidate its renewed status as an indispensable asset for central bank reserves and household investment portfolios in developing countries. Its role in portfolios may be changing in the West where economic recoveries take hold. But structurally poor demographics, high debt, and fraying globalization suggest developed world growth could also suffer.

In this context, gold provides a reliable ballast to balance portfolios vulnerable to lingering instability. An ounce of crisis insurance and dollar debasement can go a long way over what could be a volatile decade for world markets.