EM inflows mop up DM outflows

Recently, the World Gold Council (WGC) released their Gold Market Commentary, for the month of December 2023. The Commentary said, Emerging market (EM) demand for gold provided not only a ballast to lacklustre developed market (DM) activity but also helped drive gold prices to record highs.

Gold prices rose 15% in 2023 to reach US$2,078/oz, the highest annual close on record1. The closing price was also a daily record and was mirrored in all but one currency. Gold also ended the year as one of the best performing assets.

According to (GRAM), the influential drivers of gold’s return in 2023 were central banks, geopolitics, interest rates and gold’s previous (lagged) monthly return. “We estimate that central banks contributed between 10 and 15%.

As not all central bank buying is observable at a contemporaneous monthly frequency, we rely on two factors within our model to infer central bank impact: the constant (economic expansion) and the portion that is unexplained. Prior to 2022, the constant was c.4%; we believe central bank net buying has been a strong contender for driving that up to almost 8% since then” said WGC.

In addition, the unexplained portion of returns totalled 12% in 2023. If we attribute the change in the constant and all of the residual to central banks we reach a figure of 17%. A variation of GRAM in which Brent crude oil is replaced with the Geopolitical Risk Index (GPR) gives us 13%, so we settle on a figure between 10 and 15%, partly as we can’t rule out surprisingly resilient retail demand as an additional contributor.

Elevated geopolitical risk was a key driver in 2023 and is captured by including GPR in our model. This contributed an estimated 5% to returns and mitigated a drag from falling inflation and other risks (-3% contribution).

Interest rates appeared to have had a lower drag on prices than might have been assumed at the start of the year. A round-trip in the 10-year yield (both nominal and real) coupled with central bank buying and generally elevated uncertainty helped gold prices remain somewhat unscathed by volatile opportunity costs.

Nominal yields contributed c. -2% to gold’s performance, and if net out the impact of breakeven inflation it suggests the impact of real rates was c.-3%. When the monthly impacts are added together, gold’s prior monthly return created a significant cumulative drag in 2023 (-4%). But this could be viewed as a positive volatility–dampening feature of the gold market. It works in reverse too, as we saw between 2013 and 2015.

The drag from lagged returns supports the notion that the gold market is populated by price sensitive buyers alongside investors that buy into stronger prices – a feature of gold’s dual nature. We have found this to be the case in both jewellery and bar and coin segments at annual and quarterly frequencies.

Central banks may also exhibit price sensitivity, particularly if they are purchasing at regular intervals over a longer period of time-something we’ve witnessed over the last two years. Price sensitivity would explain the negative coefficient for lagged returns. And it is a factor that likely reduces gold’s volatility. When we compare gold to other commodities there appears to be a link between the lagged coefficient of the dependent variable and annualised volatility. We have added Bitcoin to the analysis to highlight that such a highly speculative asset is likely to have a higher volatility, part of which is driven by increased speculative momentum.

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top