Gold – Some Caution Warranted - Transcript

Welcome to RBC’s Markets in Motion podcast recorded June 20, 2024. I’m Chris Louney, Commodity Strategist on the Global Commodity Strategy and MENA Research team at RBC Capital Markets, guest hosting this week’s episode while Lori is out. Please listen to the end of this podcast for important disclaimers.

Three big things you need to know:

  • First, while gold prices have had a strong rally this year, having hit record highs last month, we remain cautious. We think gold is overvalued from the perspective of a number of key macro drivers, and do think there are some unrealized vulnerabilities to the pillars of gold’s rally. While we are cautious, its more because we do not think gold should be at the levels just yet.
  • Second, while May and June have seen a less weak and more rangebound trend for gold-backed ETPs, we are not convinced that investors are beginning to follow through just yet. Investors sold their gold holdings as prices rallied, and we’ve yet to see a sustained return to buying.
  • Third, central bank demand has been a key pillar to the gold rally but as China’s pause in purchasing showed, there are vulnerabilities. To be clear, we still think central bank will be strong, but there are reasons to be cautious on the volume at record prices and after such a sustained period of strength.

If you’d like to hear more, here’s another few minutes. Now, the details.

Gold has had quite a strong year already, having hit record highs above $2400/oz in May, with the strong year to date performance largely due to strong central bank, physical and Chinese demand occurring against a backdrop of eventual rate cuts, and potentially geopolitical premiums. Amid all this, we have been cautious on gold prices for a few reasons. I’ll preface my comments today by saying that it’s not that we don’t think gold will eventually get to these levels, but rather that gold prices may have gotten ahead of themselves and there could be better entry points to layer in. Today, I’ll touch on the macro backdrop, investor flows in gold, and developments in central bank demand.

Right now, we continue to cite how gold has largely shrugged off elevated yields and a strong dollar – two of the most important macro factors for gold in our and most other price models. Additionally, with the shifting expectations around the Fed’s eventual rate cuts before year-end, we have seen gold buffeted back and forth, which in our view, points to a vulnerability. This rally has largely occurred in spite of some key macro factors rather than because of them, relying instead on strong physical demand, Chinese demand, and central bank interest. While all of those themes indeed have been strong and are relevant factors for gold, rarely in recent times are they the overriding drivers of price or the most predictive parts of models on a sustained basis. Gold models often rely much more on macro drivers like rates (which remain high), the dollar (which remains strong) and other items. By most of those measures, gold is actually quite overvalued, especially when looking at these factors individually. But even when using a blended model like ours for example, gold still looks overvalued. Could this be a signal that we should readjust our modelling? Perhaps, but the fundamental pillars of this rally are not usually the most price predictive parts of our analysis on a sustained basis, nor is the relevant data most frequent. Additionally, there are vulnerabilities due to the nature of these pillars. Consumer demand can be finicky, especially at record prices, and similarly, while we agree that central bank demand will be strong in 2024, the hurdle of high prices and two years of record demand in 2022 and 2023, lead us to have some caution. Additionally, while the trend has softened, investor follow through hasn’t really materialized when it has come to these high prices, yet another source of caution for us.

Next, let’s talk about investor flows. While May and June being mostly range-bound in terms of gold-backed exchange traded product tonnage, it’s not enough for us to be too excited. During this entire year plus long rally, investors largely remained on the sidelines when it came to gold ETPs. Gold backed ETPs had started losing in tonnage terms since at least a year ago, with the secular decline driving gold holdings down from over 94 moz at the end of may 2023, to under 81 moz today. Losses were quite steady as prices rose, which led us to think that investors were aiming to hold their gold holdings flat in nominal terms, which as prices rose meant selling. This is contrary to the historic relationship where prices and tonnage held largely moved together. However, when price trends decelerated, so did losses in AUM., as we observed in our most recent commodity surveyor and other pieces, over the past month and a half, the losses in tonnage terms among gold etps decelerated as did prices. Given the more rangebound nature of gold ETP holdings recently, it is a factor to watch as perhaps this could be the bottom. However, given the ongoing lack of investor follow through which has persisted over the past year, we are yet to be convinced. Regardless, due to the fact that gold holdings represent about 73% of outstanding commodity ETP AUM, this is indeed important to watch in any outcome.

While investors have not followed through year to date, for the most part central banks have, representing one of the strongest pillars to the gold rally. This pillar however did take a hit recently with China’s central bank pausing purchases in its may data. The markets reaction to the end of the 18 month buying spree was a selloff. In our eyes, such a pause at this point after a long stretch of purchases recently occurring at record high prices seemed sort of natural in our eyes. More importantly though, it’s the caution we have been urging, as this rally has largely been based on a handful of relatively low-frequency, physically driven pillars. While central bank buying is not over, we are reminded of the vulnerability to this physically driven rally and think there may be better opportunities for investor to layer in. To be clear, we are not bearish on central bank demand or this pillar of the rally overall, a it will likely remain strong in a historical context. The desire for de-dollarization and diversification remain. Indeed, the World Gold Council released their central bank survey results recently, which showed that, 81% of central banks think total holdings will increase in the next 12 months, even if just 68% of central banks expect their own gold reserves to remain unchanged. We agree with this assessment and think that on a net basis, purchases will be strong, even if it’s hard to keep up the pace at record high prices as recent experience has suggested.

In conclusion, we continue to expect data releases and fed comments to impact gold, in many instances positively. Yet, we remain cautious overall, especially in the short term, expecting better opportunities as vulnerabilities are realized due to either macro drivers asserting themselves or some of the aforementioned pillars to the rally faltering. Our caution is not because current or higher prices won’t be justified in our view — it’s just that we think they aren’t just yet.

That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.