Gold's Record-Breaking Rally Persists: What's Behind the Rally and What's Ahead

Major Wall Street banks have acknowledged that both common theoretical frameworks and pricing models fail to explain the surge in gold price this time, which has intensified market curiosity about the players behind this upward trend and made the next move of gold even more intriguing.

Currently, the buying interest for gold is quite dispersed, including hedge funds and various central banks.

1. According to the latest research released by UBS strategist on April 9th, there has been a significant increase in buying interest from CTAs since February, with open positions for gold futures increasing by 24%. Considering that the current scale is not high compared to historical highs, the next phase of long positions still has room for growth.

"Whether we look at total net speculative positions or that of money managers', these are also only 57% and 50% of all-time highs, respectively," wrote the UBS team.

2. Central bank gold purchases have continued to support gold demand, with gold purchased by central banks worldwide over the past two years accounting for 27% of the total amount in the past 13 years. The amount of gold purchased in 2022 and 2023 accounted for nearly 1/3 of the annual mine supply, which is double the average level of the past 10 years. This trend is likely to continue since the proportion of gold reserves held by many central banks is still relatively low compared to their peers. It is worth noting that the gold purchasing activities of the central banks of China, Turkey, and India have been particularly prominent this year and remain active. As of March this year, the People's Bank of China has purchased gold for 17 consecutive months as a reserve.

3. Global physically backed gold ETFs witnessed their tenth consecutive monthly outflow in March, losing US$823mn, but the outflow rate is much slower than in previous months. This means that with the selling of gold ETFs approaching a stop, there is still significant room for future replenishment, which could also become a force supporting the rise in gold prices.

The rapid rise in gold prices in this round has caused traditional theoretical frameworks to appear ineffective. Currently, the correlation and explanatory power of factors such as the US dollar exchange rate, real interest rates, and US bond yields with gold prices are significantly weakening, and gold prices have even overcome the impact of continuous outflows from gold ETFs.

For example, since real interest rates represent the opportunity cost of holding gold and the US dollar is the primary currency for gold pricing, both are usually negatively correlated with gold prices. However, recently this relationship has been overturned, and there has been a simultaneous rise. According to UBS's model, the sensitivity of gold to real interest rates (measured by 10Y TIPS) has decreased from a historical level of -9.02 to -3.89.

The complex macro environment and FOMO (fear of missing out) sentiment may be the main reasons for the failure of traditional gold pricing models:

1. Some investors expect that as the Federal Reserve begins its interest rate cut cycle, real interest rates in the United States will decline. At the same time, the US inflation rate exceeded expectations for the first two months of this year, indicating that the last mile of fighting inflation is not easy. This further exacerbates the market's concerns about stubborn US inflation, and gold, as a traditional inflation hedge tool, becomes more attractive. Investors are focusing on Wednesday's upcoming March CPI data and minutes from the March FOMC meeting to gain more clues about inflation and future monetary policy shifts.

2. Escalating geopolitical conflicts and global economic uncertainty have led to a rush of investors into gold for risk aversion.

3. As the credibility of the US dollar-dominated credit currency system has declined due to criticism of US fiscal discipline and increased US Treasury supply, multiple central banks around the world have adjusted their foreign exchange reserve structures and increased their gold reserves. With the election approaching, concerns about the US fiscal situation may resurface, prompting investors to increase their holdings of gold.

4. As the price of gold continues to rise, the rally has likely been exacerbated by FOMO from those who have been waiting for a pullback. FOMO sentiment has also played a role in boosting this year's surges in US stocks and Bitcoin.

Taking into account the aforementioned factors, such as the anticipated interest rate reduction by the Federal Reserve and the increased demand for gold from central banks, UBS predicts a likelihood of gold continuing its upward trend. Consequently, UBS has recently raised its 2024E year-end target to $2,400 and sees the possibility of gold trading surging as high as $2,500 this year.

However, some risks are also worth noting, including the possibility of the Federal Reserve turning hawkish, the risk of profit-taking, and other factors. As a result, gold prices may face some short-term downward pressure.