One key driver behind the recent positive narrative on gold has been the renewed ‘de-dollarisation’ debate. It is argued that the US Dollar’s dominance in global trade and finance is likely to wane as more alternatives start to become available. The proposed BRICS currency could, for instance, chip away at the US Dollar’s dominance in world trade.
We remain sceptical about the prospects for significant ‘de-dollarisation’ over the next few years, given limited alternatives. For one, the relatively limited supply of gold means that a fully gold-backed currency is unlikely to achieve a similar level of scale as the greenback. However, attempts to diversify even modestly away from a concentration in US Dollars to gold can offer a key source of support for the precious metal. Indeed, 2022 was a good example of this. As the World Gold Council data showed, central bank demand for gold spiked to the highest level in decades, driving gold prices close to record highs.
Amid the excitement over potential de-dollarisation demand, we believe it is important not to lose sight of the more traditional drivers of gold prices. From a financial investor’s point of view, we continue to see real (or net-of-inflation) bond yields as one of the most important and consistent drivers of gold.
The good news is for gold investors is that a lot of the near-term headwinds have been digested. The rise in Fed policy rates and US bond yields is increasingly at odds with a falling rate of inflation. This has driven net-of-inflation bond yields higher as the Fed starts to achieve its goal of slowing inflation. However, we believe this is likely coming to an end as real yields reach levels not seen since before the Global Financial Crisis of 2007-9.
For gold, this is likely to become less of a headwind as the the opportunity cost of holding gold stabilises. That said, it is interesting to note that gold failed to break to new highs in the face of rampant, and relatively sustained, inflation. Therefore, it make take a significant shock to propel it through the 2050 high.
One area where we do see value for gold is in its role as a portfolio diversifier. During the four previous US economic recessions, gold prices rose in absolute terms. Gold also outperformed a basket of other major asset classes and offered better returns per unit of risk compared with other major defensive asset classes.
As we continue to navigate what we see as a late cycle business environment, with both upside and downside risks to asset classes such as equities, we believe gold has a role to play in delivering more stable investment portfolios.
In conclusion, gold faces a mix of positive and negative factors. On the upside, we believe demand for diversification away from the US Dollar, gold’s historical outperformance during past US economic recessions and its superior returns per unit of risk are positives. However, its failure to break to a new record high, despite inflation running at a four-decade high last year in most developed economies likely means something fundamental needs to change – potentially a sustained and sharp decline in real yields – for gold to break out to new highs.
On balance, therefore, we do not believe we are on the cusp of a ‘new gold standard’. However, Gold’s role as a portfolio diversifier, particularly during US economic recessions, is why we believe it still has an important role to play in investment allocations.
