BlackRock Olivia Markham: Gold fever

BlackRock Olivia Markham: Gold fever

The gold price tipped over $2000 an ounce in April, matching its highest level ever.

The last time gold reached these levels was during the pandemic, when the global economy appeared on the verge of collapse.

This time, the world does not appear as fragile, so what explains the recent run for the gold price? And can it be sustained?

Until October of last year, the strong US dollar had acted as a brake on gold prices.

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The Federal Reserve was the first of the developed markets to raise rates, which supported the US currency. It also saw some tailwinds from investors’ search for safe haven assets as recession loomed.

However, as other central banks caught up and a hard landing appeared less likely, the dollar started to dip.

The gold price is always influenced by a range of inter-connecting factors, but for the past six months, the weakness of the dollar has pushed the price higher.

In particular, weaker inflation data meant investors started to assume that a Federal Reserve pivot – where the US central bank starts to cut rates – may be closer than initially expected.

Gold does not pay an income, so the opportunity cost of holding it rises at times when interest rates are higher.

The gold price is also benefiting from its safe haven status.

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The market is increasingly concerned about the US government hitting its debt ceiling.

The US government’s borrowing needs to be ratified by Congress and the House of Representatives and negotiations have proved a political football in the past.

Republican presidential contender Donald Trump has already urged his party to let a default happen if the Democrats don’t agree to spending cuts.

Geopolitical tensions also appear to be having an impact.

Central banks around the world have stepped up their purchases of gold, with significant demand from countries such as China, Singapore and Turkey in 2023 for the year to date and in 2022.

Central banks may be seeking to diversify their holdings of US dollars and Treasuries as geopolitical tensions rise.  

Looking forward

Many of the factors that have driven the gold price in 2023 remain in place.

Inflation has remained relatively high, meaning real interest rates (interest rates adjusted for inflation) have remained lower.

This has helped support the gold price in spite of rising US rates. This provides us with comfort that even with potential further interest rises on the horizon in the near term, gold could fare reasonably well.

Equally, the US dollar has continued to show a very tight correlation with the gold price and its weakness appears to have momentum.

Any pivot from the Federal Reserve is likely to extend the dollar’s fall and could be good for the gold price.

Demand for gold has four main parts – investment, industrial, central banks and jewellery.

The World Gold Council shows aggregate gold demand was up 18% in 2022, the highest level since 2011.

Of these, investment demand continues to be strong, providing resilience.

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Countries such as Russia, Turkey, Kazakhstan and Uzbekistan are continuing to buy gold as a store of value and to diversify their foreign exchange reserves.

Meanwhile, we may also see a further a boost in jewellery and technology demand from China’s reopening. This should more than offset the small drop in ETF demand seen last year.

Gold equities and the gold price

Gold equities are often a leveraged way to play the gold price: they tend to rise more than the gold price when it is rising, and fall more when it is dropping.

These companies stand up on their own merits.

They have implemented significant capital discipline, striving to raise returns on their mining projects, while returning more cash to shareholders via dividends and buybacks.

The biggest risk to gold equity performance is persistent cost inflation which may pressure profit margins and squeeze companies’ ability to generate free cashflow.

The main measure of mining costs is the AISC index.

This showed record high costs for the gold mining industry in 2022, but showed some respite for miners in the fourth quarter as costs started falling.

However, we still expect higher dividend yields.

Olivia Markham is manager on the BlackRock World Mining trust

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