Do not be drawn by its beauty!

Recently, we have seen the price of gold hitting new highs. Gold is highly sought after, not just for investment purposes and to make jewelry but also for use in the manufacturing of certain electronic and medical devices. 

What are the reasons for the recent run up in price?

Central banks added a whopping 1,136 tonnes of gold worth some $70 billion to their stockpiles in 2022, by far the most of any year in records going back to 1950 as mentioned by World Gold Council (WGC). Central banks like gold because it is expected to hold its value through turbulent times and, unlike currencies and bonds, it does not rely on any issuer or government. Gold also enables central banks to diversify away from assets like U.S. Treasuries and the dollar.

As central banks started to defend their currencies against an appreciating dollar, the demand of gold returned. I will be asking if this trend is sustainable, whether central banks will continue this purchase. As one can see on the chart above, it reflected that there was hardly any trend in central banks purchasing gold historically. As inflation spiked last year, the demand for gold (traditionally a good hedge against inflation) exponentially grew. But as we are expecting inflation to come down (as shown in latest economic data), the demand for gold may decrease, causing prices to retrace.

Lower total reserves may constrain central banks’ capacity to add to existing allocations as well. Once the inflation turmoil is being contained, I don’t see a reason for a sustained demand from the central banks.

Moreover, the demand of gold from central banks only constituted a small percentage of global demand (refer to chart below).

Majority of the demand for gold comes from technology manufacturing and jewellery fabrication historically (more than 50%). As such, even tough we saw an exponentially increased in central banks purchase in the last quarter of 2022, the overall demand (QOQ) fell by 1% globally. This was because we saw a substantial decline in the demand of the precious metal in the other segment like electronics manufacturing and jewellery fabrication (refer to table below).

Where will Gold Prices go from here?

I have quoted a number of reasons why I am seeing limited upside for gold prices below and regard this moment as a good opportunity to short gold.

1. Central banks’ buying of the precious metal is not sustainable in view of lower total reserve as we are close to the end of a contractionary monetary policy cycle.
2. Current global economy is not in a very good shape. If U.S. is to enter recession in the second half of the year, this will negatively impact global economy and jewellery demand will falter in such a scenerio.
3. We are already seeing a slowdown in technological manufacturing as a result of a slowing global economy. The demand for the precious metal from this segment is expected to slow further in the months to come.
4. As global economy starts to stabilise and recover in 2024, demand of gold as a safe heaven will wane. During times of economic uncertainty, as seen during times of economic recession, more people begin investing in gold because of its enduring value (another reason for the recent run up in prices). Gold is often considered a preferred asset for investors during turbulent times.
5. The cost of gold production is c. US$1,200/oz. With the current gold price at all-time high, producers will take this opportunity to increase supply (higher margin). As more supply comes online in the months ahead, prices of gold should soften.
6. Gold prices increased post at the start of the pandemic (refer to the first chart on top) from US$1,400 to US$2,000. This is also partly due to the labour shortages and supply chain shock that the world experienced during the lock-downs. However, we can see from the chart below that supply is slowly, but surely coming back closer to pre-covid levels of 3,300 metric tons per annum. We are only about 6% lower in terms of production currently from pre-covid levels. As more supply is expected to return (as seen from the trend below) and demand from the various segments going down, prices should revert back to normalcy. Again, I don’t see a repeat of 2022 central banks purchases in 2023 (reasons cited above).

With the above factors, I see this as an opportunity to established a short position (I had already shorted at various levels; US$2,022 to US$2030). I am getting a good interest for these short position in the commodity as well.

That is all for now folks and happy investing. Wishing all a happy good Friday long weekend.