IAU - Strong Physical Demand Lifts The Long-Term Outlook For Gold

2023-04-26 00:41:00 ET

Summary

• Strong global demand for physical gold is boosting the metal's long-term outlook.
• Can gold's rally last?
• Why central banks are buying into the precious metals market.

The price of gold has been benefiting from increased global demand, including from some central banks. Bart Melek, Global Head of Commodity Strategy at TD Securities, tells Greg Bonnell some investors are stocking up on physical bullion to help offset the effects of inflation.

Transcript

Greg Bonnell: ...for a big move higher in recent weeks, but as investors consider the future path of interest rates, will that trend in gold hold? Joining us now to discuss, Bart Melek, Global Head of Commodity Strategy at TD Securities. Bart, always good to have you on the program.

Bart Melek: It's always good to be here. Thank you very much for inviting me.

Greg Bonnell: So it's been pretty interesting over the past several weeks to see this very-- I mean, pretty aggressive move higher in the price of gold. Seems to be settling in right now waiting for perhaps the next catalyst. What got us here? And what lies ahead?

Bart Melek: OK, well, it has been a very, very great time for gold. Gold, over the last 12 months has outperformed pretty much every other major asset class. It has done well last year, for much of it anyway. It has done very well this year. And our view continues to be quite positive on gold. But in the interim, we do think there is room for a bit more of a correction.

But what got us to this great performance by gold? I think gold has done very well despite of the fact that we had a very, very hawkish Fed, one that has continued to signal a very restrictive narrative for the balance of the year. Inflation continues to be high, yet gold has done very well.

And there is a bit of a two-sided story here. At the beginning of the tightening cycle, everyone agreed with the idea that we're going to have significantly higher rates and monetary policy that will be restrictive. And gold, to everyone's surprise, certainly, all the gold bugs were quite happy to see gold perform well. And we attribute this to the fact that central banks, and retail investors, and other investors around the world have very, very strong appetite for physical gold.

Indeed, last year, we saw a record 1,136 tons of gold being acquired by central banks and the official sector broadly, with even China officially telling us after a long pause that they are accumulating gold. Retail investors as well, during a period of higher inflation in Europe, in Asia, we've seen very, very, very strong demand for gold and silver, as well as investors wanted to have physical metal to protect against the ravages of inflation.

Greg Bonnell: So what are they trying to protect against by record buying of physical gold?

Bart Melek: Well, they're trying to protect against inflation, broadly. There is an element of distrust where they feel much more secure in holding physical bars as opposed to IOUs. And let's not forget that gold is no one's liability. If you have a bar, you have a bar. There is intrinsic value. Nobody has to pay you an interest rate. You just have a bar of gold that's worth something.

And for the central banks, it looks like there is continued movement towards bullion, particularly in emerging markets where we've seen the share of gold relative to the US dollar increase, and the share of dollars in FX reserves for emerging markets has been going down in favor of gold. And I think that stems from, to some extent, the sanctions that were imposed by the Western world, the US and Europe, on Russia, where it looked like half of their FX reserves in dollars and euros and other Western currencies was rendered useless. There's nothing they could do with it.

Meanwhile, gold, we suspect they can physically move over and get credits at other banks or central banks. And that's something we cannot stop. And the view out there is something we agree with, as tensions between China and the Western world, the US in particular, rise. That might be a strategy that the Chinese might want to follow. And after all, the Chinese have a massive foreign exchange reserve, about $3.18 trillion. And only about 3.6% of it is in gold.

And you compare that to the United States, which is well over 60, France, around 60, Germany, over 60, Italy, over 60. So they are very much underrepresented in the share of gold they hold in their reserves. And many reasons aside the geopolitics, you might want to have a larger share, because the dollar's share in trade may go lower and you should have currencies and assets that are consistent with your trade flows, not necessarily in what you consider to be a good investment always.

There are also worries by central banks and other investors that the US has sky high debt, unfunded liabilities in the form of Social Security and other expenditures, taxes that are relatively low, and there might be a stealth monetization where interest rates might remain lower than they ought to, and inflation higher above target. In fact, that is some reason why gold has done so well. There is a big discrepancy in what the Federal Reserve thinks the interest rates will be a year from now at the end of the year.

Within the bond market, I think I cite in my paper that there's 110 basis spreads between the dots and where the Fed funds futures market says, that moves up and down. But that is quite a chasm here, where traders, gold speculators, and investors have a credibility-- the Fed has a credibility problem with them. It will remain to be seen who is right in the end.

And if we see some of that change, we ultimately think that that spread is going to close down a little bit over the next few months. The US economy continues to do quite well. And it could very well be-- we think that it's likely we're going to have a May hike. And that's already started to price in.

Greg Bonnell: Is that the short-term pressure on gold you-- you talked a lot of constructive stuff longer term, but shorter term and medium term?

Bart Melek: I think that's probably exactly what happened. This rally, the most recent one that brought gold to 2,048 or so, the peak, we did extremely well, was very much short cover driven. So people are short covering their positions. There was, of course, some long extensions.

And now that we think that spread between where the Fed is and where the market is might be coming in, we could see new shorts being acquired again, and maybe some long liquidations where people might want to take some profits. After all, they did very, very, very well. Our view continues to be that the average second quarter price for gold will be about 1,975 average. So almost by definition, given the fact that quarter-to-date price is averaging about $2,004, so if you do the math, we're still expecting some downside.

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