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Central banks continue to buy gold. The Bank of Korea has joined the group of buyers, returning to investments linked to precious metal after 13 years.
However, the Koreans did not buy physical bars, but units of the world’s largest gold-backed ETF. During the same period, Poland once again topped the global ranking of buyers of physical gold, wrote etoro analyst Pawel Majtkowski.
Wednesday, the price of gold rose to $4,452, reaching its highest level in more than two months. However, the increase did not last long. Prices quickly pulled back, and gold is currently trading at around $4,333 per ounce. Volatility in the market remains elevated.
The immediate trigger for the rise in gold prices was inflation data from the United States. Consumer price inflation, CPI, fell to 3.4 percent year on year in July, compared with 4.2 percent as recently as May. Core inflation, which excludes the most volatile food and energy prices, stood at 2.5 percent annually and 0.2 percent monthly. Price pressures therefore remain above the Fed’s 2 percent target, but their direction is favorable for the gold market.
Lower inflation reduces the need for further monetary policy tightening in the US, which could lead to lower bond yields and real interest rates. This, in turn, reduces the opportunity cost of holding gold, which does not pay interest. If the dollar also weakens, the precious metal becomes cheaper and more accessible to investors outside the United States. Labour market data also support a more cautious Fed policy. The US economy lost 23,000 jobs in July, while the figures for May and June were revised down by a combined 103,000. The combination of falling inflation and weakening employment is usually supportive for gold, as it increases the likelihood of easier monetary policy and strengthens demand for defensive assets.
The biggest risk to gold prices remains energy prices and the situation in the Middle East. A renewed escalation of the conflict between the US and Iran or further disruptions around the Strait of Hormuz could once again push oil prices higher and increase inflationary pressure. It is worth remembering that not every war is good for gold. Geopolitical conflict affects its price in two ways. On the one hand, uncertainty increases demand for safe assets. On the other hand, more expensive oil can push inflation higher and force the Fed to keep interest rates elevated for longer. This increases the attractiveness of bonds and works against gold. The final effect therefore depends on whether investors react more strongly to fears of an escalation of the conflict or to the prospect of higher inflation and yields.
High volatility in gold is also being felt by Romanian investors, because their returns are influenced not only by the price of gold but also by the dollar exchange rate. Over the past month, gold has risen by around 7.5 percent in the US currency. At the same time, the Romanian leu strengthened against the dollar by around 1 percent, while the USD/RON exchange rate fell from 4.6 RON/USD to approximately 4.55 RON/USD. The stronger leu therefore acted as a currency cushion. When converted into our currency, the increase in the value of gold was more moderate, at approximately 6.5 percent. This is still a clear gain, but smaller than the one observed by investors whose portfolios are denominated in dollars.
Central bank purchases remain a source of support for prices over the medium term. In the second quarter, central banks worldwide bought a net 289 tons of gold. The National Bank of Poland was the largest buyer of gold among central banks globally, adding 51 tons of the precious metal. At the end of June, the NBP’s holdings stood at 632.4 tons. Poland currently ranks 10th among countries with the largest official gold reserves. It has overtaken the Netherlands and is behind Japan, whose reserves amount to around 846 tons. The NBP plans to continue its purchases and increase its holdings to 700 tons. Romania’s National Bank held reserves of 103. 6 tons of gold at the end of July, unchanged from a month earlier.
The Bank of Korea has also joined the group of gold buyers. In the second quarter, it purchased units of the SPDR Gold Shares fund worth around $250 million. This is the Bank of Korea’s first investment directly linked to gold in 13 years. It should be stressed, however, that the purchase of ETF units did not increase its official reserves of physical gold. The Bank of Korea’s physical gold holdings have remained unchanged since 2013 at around 104.4 tons.
Investors are now wondering whether the temporary move above $4,400 per ounce marked the beginning of another upward wave or was merely a short lived reaction to falling inflation in the US. The future direction of gold prices will be determined primarily by US retail sales data and changes in US Treasury yields. A weaker economy and a lower risk of further interest rate increases would support gold, as would continue purchases by central banks.
The main risks, however, are strong US economic data, weak demand for 30-year bonds and another rise in oil prices, which could push inflation higher and encourage the Fed to keep rates elevated. An important event will be Kevin Warsh’s speech at the Jackson Hole symposium on August 28. Investors will be looking for an answer to whether the Fed remains focused primarily on inflation or is placing increasing emphasis on the weakening labour market and the risk of an economic slowdown.
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