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Roula Khalaf, editor of the FT, picks her favorite stories in this weekly newsletter.
The author is a former chief investment strategist at Bridgewater Associates
Recent US inflation data has reinforced market expectations that there will be a Goldilocks-style soft landing next year, with the Federal Reserve able to ease monetary policy despite a relatively strong labor market.
In such a scenario, it would be reasonable for investors to prefer stocks and even bonds over gold. Historically, zero interest rate gold has tended to perform better at the end of the bell curve of the business cycle, whether in a recessionary environment with low and falling interest rates and increased uncertainty or in an economic overheating environment with high and rising inflation.
However, looking ahead to the year ahead, there are at least three factors that could help gold retain its luster even if hopes for a soft landing come true. Central banks are indicating that they intend to add more gold to their reserves, and China’s central bank in particular has room to do so. Additionally, China’s ongoing real estate decline, which is weighing on the country’s economy and domestic assets, could result in Chinese households continuing to rely on gold as their preferred store of wealth. Finally, investors at large may want to increase their gold allocations to hedge against an unusually hectic political calendar that could exacerbate an already unsettled geopolitical backdrop.
First, when it comes to central banks and gold, it is important to remember that reserve assets are selected primarily based on liquidity and stability, not return. That’s a big reason why central banks own so many U.S. Treasury bonds. In recent years, however, the central bank has brought another priority to the forefront: diversification to protect against geopolitical shocks. Russia’s annexation of Crimea in 2014 and the war in Ukraine in 2022 led to an increasing number of Western sanctions against Russian assets, including its central bank reserves. This triggered a renewed focus on diversifying reserves, particularly from Russia and the countries that do business with it. They wanted to withdraw reserves from U.S. dollar-denominated assets as well as assets of U.S. allies that might be inclined to impose similar sanctions.
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Gold benefited. It represented a relatively liquid, stable asset that could be used outside of global payment systems (particularly Swift) and had historically performed well during times of heightened uncertainty. According to the World Gold Council, central banks purchased a record 1,136 tons of gold in 2022, with another 800 tons purchased in the first three quarters of 2023. Emerging markets, particularly China and Turkey, led gold purchases.
China was by far the biggest buyer of gold for central bank reserves this year, purchasing 181 tonnes in the nine months to September 30, for a total holding of 2,192 tonnes. However, there is sufficient scope to increase gold holdings if further diversification is sought. Gold makes up around 4 percent of its total reserves, putting it at the lower end of major central banks’ allocations.
For comparison, Russia’s gold reserves account for almost a quarter of the country’s total gold reserves, while Turkey’s gold reserves account for 26 percent of the total reserves. The USA and Germany have around two thirds of their total currency reserves in gold. A World Gold Council survey released in May found that two-thirds of emerging market central banks and 39 percent of developed market central banks expect to increase their gold holdings over the next five years – to 16 percent or more of total reserves. That would be many times more than China’s current allocation.
In addition to China’s central bank, the country’s households, historically the world’s largest gold consumers, may also be motivated to buy more. The country’s closed capital account and less developed financial markets limit wealth management options. Historically, households have paid attention to real estate, local stock markets and bank deposits. If the government fails to sustainably stabilize real estate prices, the overall economy and the stock market are likely to continue to have problems. Against this background, it seems reasonable that household savings would shift more towards gold in an effort to preserve their wealth.
Finally, gold could play a larger role in 2024 as investors largely hedge against macroeconomic and geopolitical risks. The coming year brings elections in dozens of countries; More than half of the world’s population will decide on their leaders. The findings have the potential to trigger sweeping policy changes in key countries including the United States, Taiwan and Mexico. These votes may also exacerbate geopolitical uncertainty, potentially weighing on growth expectations and pulling hopes of a soft landing toward a more gold-friendly economic “tail.”
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