Humanityâs fascination with gold is 4,500 years old. Current opinions &emotions about gold swing from it being an unproductive investment with no cashflows, to being a store of value, to being a
hedge against inflation & human madness, to being a measure of wealth, to being an investment
avenue, to being a bet against the declining dominance of USD and so on.
While all of the above arguments hold some water, it was the last opinion that caught our attention and called for more analysis. Before we get into more details, it is important to understand the three major sources of gold demand and their respective history:
- Ornaments: Indians & Chinese have historically been the largest consumers of gold ornaments and that demand has remained steady over the years. Annually, Indians & Chinese buy around 700 tons and 900 tons respectively. It is estimated that all Indians together own around 25,000 tons of gold, which is roughly 10% of worldâs entire gold (and 3x the amount held by US Fed).
- Central Banks: Most central banks across the world hold a combination of gold, USD, and other foreign currencies in their reserves, since they are needed for exchange rate stability & trade settlement. Prior to 1974, gold used to constitute ~75% of global central banking reserves. Over the next 50 years, USD became more dominant and gold holdings as % of overall reserves touched an all-time low of 16% in 2016. This number has recently improved to ~20% due to actions of Chinese & Russian central banks (to reduce USD dependency).
- Investment demand: While this is the smallest sources of demand, it is important to note that over the last 50 years, gold has been completely dropped off from the portfolios of US & West Europeans. In a recent wealth survey, 71% of financial advisors in US said that their clientâs allocation to gold is between 0% and 1%! This is not only the lowest in the history, but also very different from a typical Indian household which has up to 15% of its wealth in gold.
From the above factors, it is clear that two of the three sources of gold demand i.e. demand from Central Banks and demand for investment are close to their 50-year lows. Should one conclude from
this that the era of gold is over? Or is there anything to suggest that gold is set to reverse this 50-year trend of demand decline?
Can the central bank demand for gold rise?
Annual gold purchase by global central banks averaged around 400 tons during 2011-21, but surged to ~700 tons in 2022, buoyed by demand from China & Russiaâs central banks. This period also
coincides with increasing geopolitical tensions â the global dominance of US is being increasingly challenged by countries like China & Russia. Smaller countries too are doing their bit by entering into
bilateral trade settlements (India-Iran), (Arab-China), etc.
In the past, US had successfully warded off the threats to its currency. But the recent situation seems a little different, because the world is increasingly getting exasperated with the Americaâs
gross misuse of USDâs reserve currency status (first in 2009 and then in 2020 by printing massive amounts of money). Thus, US will be busy fighting inflation, debt repayments, bond reissuances, and economic slowdown in the coming years and may not be able to effectively thwart the threat to USD.
In such a backdrop, non-US central banks may become keen to reduce their large stock of USD (China has already started) and diversify into other currencies or gold. Many macro commentators
opine that in periods of uncertainty, central banks a more likely to increase their gold holdings.
Can the investor demand for gold revive?
Since Indians and Chinese own gold in good quantities, the discussion here will pertain to investors in US, who over the years have almost shunned gold in favor of the typical 60:40 equity-debt
portfolio. The debt portfolios worked well for them (to reduce volatility) since interest rates in US have more-or-less declined in a straight line from 15% to 0% over the last 50 years.
However, that trend got broken in 2022 and interest rates rose from near zero levels to 5%. For the first time in 50 years, bond portfolios are seeing capital losses and witnessing volatility that is higher than gold. Right now, the hope is that interest rates will soon decline to 2-3% levels and the 60:40
portfolios will be repaired. If this does not materialize, investors will be forced to look at gold to
diversify their portfolios.
Is there enough gold to meet the above demand?
At an aggregate level, annual gold demand has remained static for many decades due to the above-mentioned reasons. In such a static demand environment, gold mining companies had no incentives
to look for new mines or improve their production efficiency. In case there is an additional demand for 300-tons on gold in 2024 due to the above-mentioned factors, there is no way that the mining companies can meet it. The new buyers will have no choice by to bid up gold prices.
What is the gold price telling us?
Gold price has made a lifetime high in many currencies including INR and is just 5% away from making new all-time highs even in USD. While this is a sign of strength, it assumes even more
significant because it has happened despite the sharp rise in interest rates in US (in the past, gold
prices would decline when bond yields increased).
US stock markets and gold has had an inverse correlation since 1950s. US markets did very well 1980-2000 and 2010-2021 while gold did very well in 1970-80 and 2000-2010. Based this, it seems
gold can do well between 2021-31. If one looks at the ratio of market value of Gold v/s S&P 500, it is
at depressed levels seen only twice in the history i.e. the inflationary era of 1970s and the tech bubble of 2000. We all know that gold prices rallied 2-3x in the years that followed.
What should investors do?
While no one can ever know with certainty if history will repeat, the current backdrop offers one of the most favorable environments for gold prices to rally. Ideally, we advocate investors to have 5-10% of their wealth in gold. But given the possibility of gold doing well in the next 2-4 years, one can
consider a slightly higher allocation as well.
Trivia – Update on Gold & Amul butter
Indiaâs ancient economic & food sciences have assigned huge importance to Gold and Ghee, so much that Charaka Samhita, the Sanskrit text on Ayurveda, opines âsell your gold if you have to, but never stop eating gheeâ. Thankfully, all of us are now in situation that we can own gold and eat butter as
well. Below is an illustration of how owning gold can ensure that you never have to worry about the
rising prices of ghee/butter!
| How much butter can you buy? | 1970 | 2021 | 2023 |
|---|---|---|---|
| With One rupee | 100gm | 2.4gm | 2.2gm |
| With One US$ | 0.60kg | 0.15kg | 0.14kg |
| With One gram of gold | 1.5kg | 11kg | 12kg |
Note: We do not understand or share the same optimism for Bitcoin and other crypto – currencies. Many of the data points mentioned in the above report have been obtained from blogs, articles and videos of investors whom we respect and follow. The above article should be treated as educational
and not be construed as an investment advice.