Recently, I read an article discussing how private investors and central banks in Asian markets are now driving the price of gold. This is probably a surprise to most of us in the United States. In fact, China and India alone account for half of world demand for gold, while U.S. investors represent less than 10% of the market.
These facts are important to know in order to understand why gold prices in other countries are rising while prices in the U.S. have plateaued in recent months. Another factor central to understanding today’s market is that gold is sold worldwide in U.S. dollars. Investors using other currencies to buy gold must first convert their currency to dollars before making their purchases.
These two factors—the dominance of Asian markets and the dollar-denominated pricing of gold—are crucial to understanding why now is a great time to buy physical gold.
A strong dollar makes gold more expensive in other countries, and several factors are currently supporting a stronger dollar.
Because gold is sold in U.S. dollars, a strong dollar makes gold more expensive in terms of other currencies. For example, an investor currently using the Chinese yuan will find that it takes more yuan to buy dollars before making a gold purchase. Since this makes gold more expensive in yuan, gold demand is suppressed in Chinese markets.
Why is the dollar so strong? Because in its efforts to quell inflation, the Federal Reserve has raised interest rates higher and faster than other central banks have done. Our economy is the strongest among major economies, allowing the Fed to set high rates without damaging the economy (so far). Since other economies are weaker, other central banks have been less aggressive with their interest rates for fear of triggering a recession.
Another factor supporting the strength of the dollar is the security offered by U.S. Treasuries. Because these assets are considered the safest in the world and because interest rates on U.S. Treasuries are currently very high, people from around the world are pouring money into dollar-denominated Treasuries, essentially selling their own currencies to buy U.S. dollars. And just like with any other product, currencies are subject to the law of supply and demand; higher demand for dollars (to buy Treasuries) increases the price one pays for dollars (in terms of the other currency).
A higher gold price in other currencies can suppress foreign demand for gold.
International demand is incredibly important to the price of gold. In fact, 93% of gold is sold outside the U.S. market. So when a stronger dollar increases the price of gold in other currencies, it suppresses gold demand in markets with weaker currencies. Today, that is virtually worldwide.
In my view, this is a primary reason why the recent rally in gold prices came to an end last spring as the Fed defied market expectations and continued to raise interest rates. Another reason has been the deteriorating Chinese economy, which is taking its currency, the yuan, with it. This dynamic is reinforcing the effects of high interest rates for U.S. Treasuries and is rapidly raising the price of gold in the Chinese market.
When will we see the revival of last year’s gold rally? The answer may lie with the Federal Reserve.
I expect the current dynamic between the U.S. dollar and gold prices to fade as the difference between interest rates in the United States and elsewhere narrows. That will occur when the Federal Reserve begins lowering rates and/or other central banks begin raising theirs. Because other economies are so much weaker than ours, we’re more likely to lower rates than others are to raise them.
When will the Fed begin lowering rates? Take the Fed at its word. It won’t lower rates until inflation is closer to the Fed’s target of 2% or the U.S. economy begins to show clear signs of weakness. I don’t expect to see lower rates until Q1 or Q2 of 2024, and between now and then, we’re likely to see another .25-point increase.
The good news is that the United States has had greater success fighting inflation than any other major nation, which means we’re in the best shape to begin lowering rates. When that occurs, the dollar will weaken, and the price of gold in other currencies will decline, leading to stronger demand for gold in those markets (which, again, account for 93% of world demand). Stronger demand in those markets will raise gold prices in U.S. dollars.
But there’s a caveat to my predictions: China.
While nearly all global gold demand comes from outside the United States, a full 25% of that demand comes from China. However, the current crash in the relative power of the yuan and the weakening Chinese economy seem likely to suppress gold demand from China, independent of what the Federal Reserve does with interest rates.
On the other hand, if the Chinese economy continues to deteriorate, Chinese elites and the middle class may, despite higher prices, increase their purchases of gold as a way to preserve wealth in the face of expectations that the yuan will continue to fall.
So in China, it’s complicated.
The prospects are good for gold prices to rally once again—and it may happen soon.
Once it’s clear that the Federal Reserve is finished raising interest rates, I believe the prospects are good that another gold rally will begin to build momentum, becoming fully realized once the Fed actually begins to lower rates. For two reasons, I believe that time will come in the first half of next year.
First, I’m optimistic that the Fed will continue to have success against inflation, although there are some risks on the other side of that equation. Second, 2024 is an election year, and there’s a pattern of the Fed loosening the reins leading into presidential elections. Not always, but often.
Bottom line: While gold prices have slipped somewhat since their historic high in early May 2023, I expect prices to firm up once markets become confident that the Federal Reserve has topped out on rates—likely this fall or winter. Then I expect the rally to resume in Q1 or Q2 2024 as markets foresee interest rate reductions.
But it’s possible the rally could begin even earlier if inflation falls faster than expected or the economy suddenly shows signs of weakness.
This pause in gold’s rally creates an opportunity for those looking to add physical gold to their portfolios. Now may be the time to buy.
