Gold Rush 2024: Geopolitical Shifts Provoke Central Bank Buying

While it hasn’t had the splashiest of headlines like cocoa, coffee, or copper this year, gold has been putting together a solid rally over the course of 2024, with front-month roll-adjusted futures up +19.1% to July 17th. One of the most interesting things about the rally has been that it’s happening at the same time as the U.S. dollar has been strengthening and real yields have risen, which doesn’t generally happen. Because gold (as well as most other commodities) is priced in U.S. dollars, when the value of the U.S. dollar rises, this reduces demand as gold becomes more expensive. The daily correlation between gold and the USD index since 2010 is -0.37, which generally means that on days when the USD index is rising, gold prices are falling.

Furthermore, because gold is generally held as a store of value as opposed to being consumed in an industrial capacity, there is a negative yield associated with holding gold as it costs money to store, insure, etc. and there is no underlying cash flow. Because gold has a negative yield, when real interest rates rise, the opportunity cost of holding gold also rises, further reducing demand. Like the USD index, gold and U.S. 10-year real yields have a daily correlation since 2010 of -0.30, so you would expect that when real yields in the U.S. are rising, gold prices are likely under pressure.

However, despite the headwinds of both the rising U.S. dollar (up +2.9% year to date) and rising real interest rates (up +0.19% year to date), gold has been one of the best performing commodities so far in 2024.

While gold has been getting a boost from the potential for additional fiscal stimulus via corporate tax cuts (inflationary) and the potential for interest rate cuts from the Fed later this year, another one of the catalysts underpinning the rise in gold prices has been an increase in physical demand for gold from central banks. Bloomberg reported earlier this month that the Reserve Bank of India added more than nine tons of gold to its reserves in June, the largest monthly increase since July of 2022. India has now expanded its gold reserves to 841 tons, joining other countries such as China and Turkey, who have been adding to their own domestic reserves. Emerging market central banks have recently been stepping up their physical gold purchases, looking to enhance the flexibility of their foreign currency reserves after the Russian Central Bank had almost $300 billion of its assets frozen following the Russian invasion of Ukraine. In the relatively new book Paper Soldiers: How the Weaponization of the Dollar Changed the World Order, author Saleha Mohsin details how the U.S. government has increased its reliance on economic sanctions since 9/11 as a means of enforcing its international agenda. Relying on economic sanctions to apply pressure to malicious foreign actors—as opposed to military conflict—has been a particularly good strategy given how important the U.S. dollar and the U.S. banking network is to global commerce. However, the effectiveness of applying economic pressure on countries like Venezuela, Iran, Afghanistan, and Russia has been both a blessing and a curse, as it has opened the question on whether countries will now look for solutions outside of the U.S. dollar to increase their flexibility should they find themselves on the wrong side of a U.S administration in the future.

While freezing the Afghan central bank’s U.S.-based assets after the Taliban regained control of Afghanistan is one thing, the freezing of Russia’s central bank assets is arguably a watershed moment in the weaponization of the U.S. dollar, as it effectively cut off the world’s 11th largest economy, and a member of the G20, from the global financial system. In her book, Mohsin mentions that Treasury Secretary Janet Yellen had to be convinced about implementing economic sanctions on Russia, concerned of the unintended consequences this might have on the U.S. dollar’s reserve status. Since then, Yellen has commented that there is no threat against the U.S. dollar from the sanctions levied against Russia, though it’s likely something that is on the mind of the Treasury. Earlier this month, Bloomberg reported that Saudi Arabia had indicated its displeasure with the G7, exploring various options for additional financial support for Ukraine, one of which included a direct seizure of the Russian central bank’s frozen assets. While the eventual outcome was to only access the profits on the frozen funds for Ukrainian support, it does highlight how much of a hot button topic this has become. With Saudi Arabia holding $135 billion of U.S. treasuries and its central bank holding what is likely the bulk of its $445 billion net foreign reserves in U.S. dollars, it likely doesn’t want a precedent set that can be used against other countries in the future.

Javier Blas from Bloomberg wrote a piece near the end of June about how the death of the ‘petrodollar’ is greatly exaggerated, and while I agree that the majority of commodity deals will likely continue to take place in U.S. dollars, I don’t think we can rule out the possibility of a diminishing importance of the U.S. dollar in the future of global trade. While I don’t think we’ll see another foreign currency usurp the U.S. dollar in its ‘pricing’ of commodities or as a global reserve currency anytime soon, I think we will continue to see more countries aim to reduce their dependence on the U.S. dollar by settling trade deals outside of greenbacks. At the end of last year, JPMorgan estimated that 20% of physical oil deals took place in currencies other than the U.S. dollar. While Russian sanctions have necessitated settling Russian oil exports in currencies like Chinese yuan and Indian rupees, last summer the U.A.E and India signed a deal whereby a shipment of Emirati oil was paid for with Indian rupees.

While we’ve spilt much ink on how ongoing fiscal deficits are beneficial for stores of value like gold and silver, the ongoing weaponization of the U.S. dollar through economic sanctions and the increased central bank demand for gold is another aspect that has helped push gold prices higher. In a world where we are moving away from globalization and there is heightened macroeconomic uncertainty, there is the possibility that gold and other strategic commodities may start to diminish the role of the U.S. dollar in global trade. This should be a long-term tailwind for broad commodities, but especially gold and other commodities that can reside outside of the global banking system.

Happy investing!

Scott Smith
Chief Investment Officer