By: Michael Kruger, Senior Investment Analyst at Morningstar SA

Our investment team at Morningstar has written previously about the history of gold as an investment and the potential role it may play in providing protection against an equity market decline, as a possible inflation hedge and whether including gold in a portfolio can improve long-term returns or risk-adjusted performance. Given the recent move higher in the precious metal, these considerations are again front of mind for investors, who are trying to decide whether an allocation to gold may be appropriate for their portfolios.

To set the scene, it is worth highlighting the significant upward moves that we have seen from gold over the past few months. Gold reached an all-time high of $2,450 per ounce in May 2024, and has delivered a year-to-date return of 13.0% and a return of 19.5% over the past 12 months (to the end of May 2024). In this article, we explore what has been driving the strong upward moves that we have seen in the gold price.

What’s interesting about the recent surge in the gold price from late 2022 to early to mid 2024 is that it came during a period when market participants would not have expected the yellow metal to rally significantly. Gold prices tend to be negatively correlated to real interest rates. The lack of cash flow generated from gold increases the opportunity cost to hold it as interest rates rise and the opportunity cost to fall as interest rates fall.

What you can see from the red bars in the left chart above is that real interest rates have risen significantly since the US Federal Reserve started hiking interest rates aggressively, starting in March 2022, to tame rampant inflation. This has coincided with strong upward movements in the gold price, which is a bit of an anomaly when looking at the inverse relationship between real interest rates and the gold price that has persisted historically.

Another interesting observation is that the recent rally in the gold price has coincided with a period of outflows from gold ETFs, which is evident from the red bars in the right chart above. The previous strong run up in the gold price in 2019 and 2020 was supported by strong inflows into gold ETFs, however, the recent rally does not appear to be supported by gold ETF purchases.

So, what is behind the recent rally in the gold price? Firstly, it is worth highlighting that there has been an obvious increase in geopolitical risks due to the ongoing wars, starting with the Russian invasion of Ukraine and then the outbreak of hostilities in the Middle East. This has driven the demand for gold, which is often viewed as a safe haven asset.

Other factors which have impacted the demand for gold are macroeconomic uncertainties created by high global inflation, concerns over the global recovery from the pandemic lockdowns, and more recently, worries over the outcomes of the numerous national elections taking place in 2024.

As the graph above highlights, unusually high central bank buying of gold has also contributed to the precious metal’s record highs. In 2022 and 2023 there were over 1,000 tonnes of gold purchased, compared to the historical average of around 400 tonnes.

If we drill down a bit further, the most notable central bank purchases over the past 4 years appear to be coming from the People’s Bank of China (PBOC), the Reserve Bank of India and the Central Bank of Turkey. Their reported primary reasons for purchases have been gold’s value in times of crisis, its benefits of diversification and being a long-term store-of-value and inflation hedge.

The recent surge in central bank purchases of gold since 2009 and a rising gold price has grown the precious metal’s share of global international reserves to the detriment of fiat currencies. While the US dollar still dominates the share of global international reserves, gold has now surpassed the euro as the second most dominant portion of global international reserves.

If we reduce the analysis to simply focusing on the US dollar and gold’s share of global international reserves, it appears to indicate that the US dollar’s share of global international reserves is trending lower, while gold’s share is increasing. The reduction in the share of global international reserves held in fiat currencies may be caused by declining trust in “credit assets” due to worrying asset bubbles, escalating sovereign debt, the breakout of major wars and inflation fears. This appears to be driving the continued demand for gold rather than fiat currencies and it will be interesting to see whether this trend continues going forward.

In conclusion

Interestingly, the recent rally in the gold price has not been supported by positive movements in real (after inflation) interest rates or flows into ETFs. Instead, the strong upward moves appear to be driven by central bank purchases of gold in China, India, and Turkey as well as some other Asian and Eastern European countries. The recent rally in the gold price as well as the increase in central bank purchases has increased gold’s share of global international reserves, with gold surpassing the euro as the second largest component of global reserves. While the US dollar still maintains a healthy lead in terms of its share of global international reserves, the trend appears to indicate that gold may be gaining ground at the expense of the greenback.

So what? A brief note on Morningstar’s view on gold as an investment

Although not the specific focus of this article, it is worth touching briefly on Morningstar’s view on gold as an investment. The introduction of gold in a portfolio is not guaranteed to improve risk, returns or risk-adjusted returns for every period based on historical evidence. Rather, the track record of the precious metal is mixed, and gold can go through long periods of underperformance. The strongest evidence for holding gold appears to be as a safe haven in periods of significant market volatility. Our current view is that it should be viewed as an insurance policy rather than a core holding and should not make up a significant portion of a client’s portfolio, due to its inability to deliver significant long-term real returns.