Gold: are we facing a unique opportunity after recent price breakout?
26 SEPT, 2024
By Ned Naylor-Leyland
Author: Ned Naylor-Leyland, investment manager, gold and silver, and manager of the Jupiter Gold & Silver Fund at Jupiter AM
Gold has been one of the best-performing asset classes in 2024 following its upward breakout in March. This trend is explained by a combination of factors, such as expectations of interest rate cuts and central bank purchases.
Surprisingly, its excellent performance has not been accompanied by investment inflows. In recent months, inflows have not managed to offset the $3 billion lost by gold ETFs globally so far this year. This continues a broader trend that has been with us since 2022, marked by a steady decline in investment flows into gold ETFs. What is causing this, and what needs to happen for the trend to reverse?
Capital outflows driven by increased competition from new alternatives
The constant capital outflows from gold ETFs over recent years can be attributed to factors such as rising interest rates, the boom in technology and AI-related stocks, and greater competition within the alternative asset space.
As central banks raised interest rates to combat inflation, the opportunity cost of holding non-interest-bearing assets like gold increased. Investors were drawn to higher-yielding bonds and other fixed-income securities, resulting in lower demand for gold ETFs.
Similarly, the incredible rise of technology and AI in the post-pandemic recovery has made higher-risk assets like equities more attractive to investors. As a result, gold, often perceived as a safe-haven asset during periods of economic slowdown, has lost some of its appeal.
It’s also important to note that most investors use gold as a diversifier within a broader, balanced portfolio of stocks and bonds. The rise of other alternative investments, such as cryptocurrencies and digital assets, has also contributed to gold’s declining popularity. These assets offer diversification benefits and the potential for higher returns, making them more attractive to investors seeking alternatives to traditional assets like gold.
Paper planes, golden levers
The gold market is dominated by paper contracts, such as futures, options, and exchange-traded funds (ETFs). These financial instruments represent the right to buy or sell physical gold at a future date but are not the physical metal itself. In fact, only a small percentage of daily gold trading involves physical bullion. This means that gold prices are heavily influenced by factors unrelated to the physical metal's supply and demand, but rather by macroeconomic elements and trading patterns of large quantitative funds. Quantitative funds, which use algorithmic trading strategies to execute large-scale trades, have played a key role in the process whereby the price of physical gold has become disconnected from demand.
It seems that the sharp rise in gold from $2,150 to recent highs above $2,600 per ounce has been driven by gold futures purchases from trend-following quantitative strategies. These strategies can create momentum effects, where a small price move is amplified by a large volume of automated trades. They also tend to develop similar trading strategies, leading to crowding. This can result in self-fulfilling prophecies, where a rising price leads to more buying by quantitative funds, further driving the price up.
A golden opportunity
Given that the recent sharp rise in gold prices appears to be primarily due to factors such as strong Chinese demand, increased central bank purchases, and trend-following strategies of large quantitative funds—rather than significant inflows into ETFs—a more substantial upward price breakout could occur once ETF flows systematically turn positive. When this happens, it is likely to trigger rapidly, presenting an opportunity not seen in over fifty years.
