Gold soared on EM central bank buying to diversify from USD

On Friday, Wall Street Futures, Gold, and US bonds slipped, while USD surged on hotter than expected US NFP/BLS job report; Gold slid from around 2300 to around 2280 but soon jumped to around 2332 on haven flow amid the concern that Iran may soon launch the retaliatory missile/drone attack on Israel in the weekend either directly or through some proxies (like Hezbollah, Houthi, etc).

Gold is getting a boost from growing geopolitical tension over Israel-Iran/Gaza war, the lingering war between Russia-Ukraine/NATO and a potential small WWW-III, the never-ending global deficit, debt, devaluation, and an imminent synchronized global easing (QE-QT vicious cycle every 5-10 years; whenever US Fed B/S-Bank reserve goes below 25-20% of nominal GDP, some kind of REPO/funding market crisis begun and Fed has to step in with QE again).

Gold is also getting a boost from Central Bank buying like PBOC (China), RBI (India), and others amid a strategy to diversify FX assets. As per the latest data, in Mar’24, China held 72.74 million fine troy ounces of gold, up from 72.58 million ounces at the end of February, the 17th straight month of increase, resulting in the value of China's gold reserves rising to $161.07B from $148.64B.

Apart from the concern of USD devaluation, there are also some concerns that the US is using USD sanctions as a weapon/tool against enemy countries (like Russia for the Ukraine war) and even seized legitimate Russian financial assets in USD/UST. Thus most of the central banks except G7/G10/US allies are now gradually diversifying into Gold from US/EU bonds. This along with growing retail demand from China (after COVID recovery) amid property and stock market pain is causing higher demand for the yellow metal, while at the same time, global production of Gold is steadily dwindling.

Global Gold production was gradually rising from around 2470 MT in 2005 to 3644 MT in 2023, but recently the production growth has slowed, while the US Geological Survey estimated that all known viable gold reserves may be depleted in the next 17 years. On the other side, global Gold demand including OTC and ETF flows has increased to around 4899 MT in 2023, at a new life time high led by jewelry consumption (2093 MT) and global central banks (1037 MT). Leading global gold producers are China (370 MT), Russia (310 MT), and Australia (210 MT). Overall, around 50% of global Gold demand comes from jewelry, 20% from central banks, and 10% from industrial use. Recently, there was a net outflow from Gold ETF against a higher inflow in BTC/Crypto ETF.

Image Courtesy: Zero Hedge

The U.S. Fed/Treasury has the highest declared Gold reserve around 8.13 MT, followed by Germany (3.35 MT), Italy (2.45 MT), France (2.44 MT), Russia (2.33 MT), and China (2.19 MT). The U.S. may have a higher Gold reserve as it may have seized the Gold reserve of Ukraine and Israel to some extent instead of Military aid and even some Russian Gold. In a way, despite comparable GDP size, China has much less Gold reserve than the U.S. and now China is scrambling to hike its gold reserve so that the global credibility of its currency (CNY) increases and CNY may compete against USD, and EUR as another global reserve currency.

Similarly, India has also comparatively lower Gold reserve of around 0.80T and thus the RBI is also buying and diversifying its FX reserve. Russian central bank is also a buyer, as it does not hold any USD assets after the Ukraine war and US sanctions. Russia officially has not held any USD assets since 2018 as it was preparing for the eventual US sanction, even if it may not have launched the Ukraine war. The U.S. Treasury usually ‘switches off’ the SWIFT facility for any USD payment to a sanctioned country/person as a 1st step, so that no transaction is possible in USD.

Thus Russia as well as other BRIC countries including India, Saudi Arabia, Brazil, and even South Africa are now trading among themselves with mostly Chinese Yuan, especially Russia is seeking Yuan from India for its export of oil. Russia is using that Yuan to buy goods (imports) from China etc. Also, various other countries including Europeans are now transferring their Gold reserve from the US to their respective country (domestic storage; no more storage in the US).

Apart from US sanction concerns and gradual de-dollarization effort, Gold is also being boosted by growing political and policy uncertainty in 2024, when more than 60 countries are going for national/general/presidential elections led by India, the US, Mexico, Indonesia, and several other European countries. The vicious cycle of huge expenses in these elections, especially in India, funding of black money (mostly through fiscal stimulus path/leakage), resultant fiscal deficit, higher borrowing costs, elevated inflation, never-ending money printing, and the ultimate devaluation of flat currency is boosting Gold, which is seen as the backstop of all haven assets.

Also elevated oil now hovering around $85 is boosting inflation expectations and Gold is an ideal/traditional hedge for decades after decades. Gold is a natural resource in limited/depleted quantity, which no central bank can print, unlike paper currency. The purchasing power of the Indian Rupee also decreased dramatically in the last 75 years (since 1947 independence);

USDINR was around 4.16 in 1947, against the present exchange rate of around 83.50; the price of 10 gm gold was around Rs.44, around Rs.89 in 1947, Rs.18500 in 2010 now around Rs.71000 in 2024. Chinese currency is much more stable than INR against USD and also Gold. In 1970, USDINR and USDCNY were both around 7.50 and 7.23; now in 2024, USDINR is around 83.50, while the USDCNY remains around 7.25, almost the same devaluation of INR/Indian Rupee, despite China's ss the exporter powerhouse of the world and exports much more than India.

 

Bottom line:

Fed may continue QT (even at a slower pace) and go for a rate cut cycle at the same time despite these two policy actions being contradictory. Thus the Fed may go for rate cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%. Fed may bring down further its B/S size from present around $7.5T to $6.55T through QT tapering by May-Dec’25 to keep minimum/ample liquidity for the US funding/money market and also to prepare itself for the next cycle of QE, whatever may be the recession excuse.

The market is now expecting 5 rate cuts (-125 bps) in 2025 against the Fed’s official 2-3 rate cuts; the Fed may go for 4 rate cuts in 2025 if Trump comes to power/White House or even under Biden. Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and 3.50% US 10Y bond yield to ensure financial stability. Gold is boosting on the hope of another wave of rate cuts and then the eventual QE when the B/S size of the Fed will go down below 20% of nominal GDP.

Technical trading levels: Gold

Whatever may be the narrative, technically Gold (XAU/USD: 2365) now has to sustain over 2375 for any further rally to 2400/2425; otherwise sustaining below 2365/2325, may again fall to 2320/2315-2305/2300 and 2290/2270-22245/2240, and 2220/2210-2200/2195-2190/2180 and 2175/2145*, and further to 2120/2110-2100/2080-2060/2039 and 2020/2010-2000-1995/1985-1975 and even 1940 may be on the card.