Gold bars for sale in Kelantan, Malaysia. File photo
Gold’s surge to an all-time high seems to be explained in the most obvious way, given the difficult geopolitical environment and the gloomy outlook for the global economy. The precious metal is known as a “safe haven” and the general view is that bullion prices will rise as interest rates fall – something many investors see happening later this year.
But not yet. Take a closer look and the mystery emerges as to why gold is suddenly rising in price now?
After trading fairly flat for months, bullion prices began to surge in early March. They have since risen 14%, posting a string of daily records. But geopolitical tensions have been running high for months, even years, and the outlook for when the Federal Reserve will cut interest rates has become even murkier in recent weeks. So what changed to cause such a surge in gold prices?
Seasoned executives and analysts offer very different answers to the question of who or what is driving gold to its all-time high: Are central banks worried about the dollar’s role as an economic weapon? Are funds betting on an imminent Fed rate cut? Are an army of algorithmic traders attracted to gold simply because it is rising? Is it persistent inflation and fears of a hard landing? Is it a weakening currency? Is it the upcoming U.S. election? Or is it some combination of all of the above?
This mystery has prompted industry insiders to investigate a massive global trading system spanning existing exchange-traded funds and futures trading, from New York, Shanghai to a giant over-the-counter trading center in London along with a network of dealers spanning the world, selling gold bars, coins and jewelry to everyone, everywhere.
It’s a murky and complex world that has historically been difficult to open up. But regulators have been working for years to increase transparency, increasing access to data that sheds a little more light on the concentration of gold in one of the world’s oldest stores of wealth.
Who is buying gold?
First, the easy answers: central banks, as well as major institutions and traders, are preparing to move to ease interest rates; Chinese consumers are worried about declining returns from other assets and a devalued currency; on Reddit, gold collectors brag about hoarding gold bars and coins.
But those groups have been driving gold’s price gains for months—or years, in the case of central banks—and it’s unclear why any of them are buying gold now with any more fear, greed, or excitement. Analysts are better equipped with market data than they were in the past, but the answer to that question is vague: It’s that everyone is buying at the same time, and no one is buying particularly much.
Gold jewelry is displayed for sale at a store in California, USA.
What kind of gold are they buying?
One thing is clear but also puzzling: Investors are not buying gold exchange-traded funds (ETFs), one of the easiest ways to buy gold. But the continued outflows from gold ETFs suggest that a large group of investors are missing out, or have taken profits on the rise in gold prices.
“This is one of the strangest phenomena I’ve ever seen in the ETF space,” said Nate Geraci, president of the ETF Store. “What’s particularly interesting is that demand for gold is strong across other channels, including central bank purchases and direct purchases by retail and private investors.”
Citigroup explained that profit-taking by long-term investors who bought gold years ago is the reason for the significant decline in ETF net inflows. Joe Cavatoni, ETF platform manager at the World Gold Council, explained that the strong net selling by these funds without causing significant downward pressure on gold prices is a sign of strong demand for the bullion they are selling, and that central banks will be the traditional buyers.
“There are other investors who are buying physical gold, so the ETF sell-off has no impact [on gold prices]. Guess where it goes: to the over-the-counter (OTC) market, or to central banks,” Cavatoni said in an interview.
Where do investors buy gold?
Trading activity is picking up on futures exchanges and over-the-counter markets, signaling that institutional buyers – central banks, investment banks, pension funds, sovereign wealth funds – are all getting in. Gold options trading is also picking up, and there are expectations that bullion prices could rise further as options dealers step up buying to offset risk.
The number of gold contracts on the New York futures market is rising, a sign that fund managers are betting on higher prices in the longer term. But overall trading volume has far outpaced the number of open contracts - suggesting a surge in algorithmic trading funds.
Why are investors buying gold at this time?
That’s the big question. The glaring flaw in the story over the past five weeks is that while the Fed is still expected to start cutting rates this year — which would be good for gold — many investors are less convinced about the timing of the cuts than they were a few months ago.
One possibility is that some gold investors have stopped caring about when the Fed will start cutting interest rates, and are instead focusing on the prospect of a hard landing in the US economy based on recent data and are rushing to buy bullion because of its role as a “safe haven.”
This could also explain another strange move in the gold market in recent weeks: the relationship between gold's price differential and Fed interest rates.
The percentage spread between spot gold and three-month London futures — which tends to move in line with interest rates due to the cost of storing, financing and insuring gold — has narrowed to below the Fed funds rate in recent weeks as spot gold prices surged. This is rare, and historically has only happened on a sustained basis when interest rates are low or about to fall sharply.
Such a reversal of the spread could signal that nervous investors are stepping up purchases of spot gold, as a hedge against potential turmoil.
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