Record purchases of gold by central banks have helped push the share of gold in investors’ portfolios to the highest level since 2012, according to data from a new metric developed by JPMorgan analysts.
“We have previously reported in our publications that at the global level, the share of commodities (excluding gold) in investors’ portfolios has fallen below neutral (historical average),” the analysts said. This raised the question of how to measure the share of gold in investors’ portfolios.
“To answer this question, we developed a new metric that shows how much gold makes up investors’ portfolios globally” they said. “Specifically, we focus on how much gold is held for investment purposes, whether by central banks or private investors who have bought coins, bullion or physical gold exchange-traded funds (ETFs)”.
Analysts used data from the World Gold Council (latest as of the end of 2022). For the second quarter of 2023, a forecast was used based on the gold purchases reported so far by central banks and private investors. Then they divided the amount of gold purchased for investment purposes by the amount of financial assets (investments) of all private investors (banks not included), which includes money, stocks and bonds. The graph below shows the share of gold in these financial assets.
Share of gold in investors’ portfolios (percentages). Source: Bloomberg/JPMorgan.
JPMorgan announced that their metric shows a decline in raw material investments, but the share of gold has instead been increased over the past year. Gold purchases by central banks have been a big factor here.
Over the past year, central banks have increased their gold reserves at a historic rate. Interest in buying gold has mainly come from Asia, where they want to reduce dependence on the US dollar. More active buying began after the start of the war in Ukraine in early 2022.
“Whereas the share of gold has increased since the pandemic and has reached its highest level since 2012,” they wrote. “In other words, the share of gold in investors’ portfolios is quite high by historical standards. It must be assumed that the increase in gold purchases by central banks will be supportive for gold.”
Analysts pointed out that recently the pace of gold purchases by central banks has decreased slightly, and this may also start to affect the share of gold in investors’ portfolios. At the same time, it was mentioned that mainly gold purchases have decreased due to Turkey, which has intervened in the local gold market.
Net purchases of gold by central banks (World Gold Council data). All countries except Turkey (in blue) and Turkey (in gray).
According to data from the World Gold Council, after three months of heavy selling, Turkey has increased its gold reserves again by 11 tons in June.
Link to real interest rates
“In the future, it will be clear whether the reduced gold purchases by central banks in the second quarter of 2023 is a temporary phenomenon. Given that the change has taken place mainly in one country, this may well be the case. Another possibility is that central banks’ buying interest has cooled, because the price of gold remains at historically high levels” they said.
If central banks’ recent normalisation of purchases continues, it would also restore gold’s historical sensitivity to real bond yields, they explained. Historically, it has been the case that a high real yield on bonds (return adjusted for inflation) has had a negative effect on gold, while a low real yield has had a positive effect on gold. In 2022, however, that relationship broke somewhat, analysts said.
“Quarterly changes in gold prices were much larger than we would expect based on the increase in US 10-year bond yields. “If we look at the data from 2010 to 2021, we see that every 100 percentage point increase in the US 10-year Treasury yield has translated into a $209 drop in the price of gold (and vice versa),” they wrote. In the graph below, the quarters of 2022 are marked in red, which differ significantly from the data of previous years.
Gold price change (in dollars, Y-axis) and US 10-year bond yield change (X-axis). Source: WGC, Bloomberg, JPMorgan.
“If you look beyond the relationship between the gold price and the real yield of bonds, there is no doubt that gold purchases by central banks are of key importance in the further movement of the gold price. Whereas the importance of central banks in the market has increased since the pandemic.”
JPMorgan analysts pointed out that the most important correlations of the gold price have changed since the outbreak of the coronavirus crisis.
“Before the pandemic, of the demand components, the price of gold had the highest correlation with the inflow and outflow of money in gold ETFs (exchange-traded funds). It was also the most important component to monitor. “Since the pandemic, the gold price has had the highest correlation with central bank purchases” they said.
The bank predicts new price records
JPMorgan is also forecasting big records for the price of gold. In a report published in July, Greg Shearer, the bank’s managing director of commodities research, predicted that gold prices would rise to new records in the second half of next year.
Shearer wrote that he expects the Federal Reserve to start cutting interest rates in the second quarter of 2024. This will cause US real interest rates to fall, which will have a significant positive effect on gold. He forecasts that gold will average $2,175 an ounce in the fourth quarter of 2024.
However, if the US economy should be hit by an economic depression, there is more upside potential, Shearer said. He added that the deeper the recession, the more the Federal Reserve will have to cut interest rates, which will support gold.
“Gold is in a very good place. “We believe that owning gold will provide good asset diversification in the final phase of the economic cycle, and in addition, gold should do well over the next, say, 12-18 months,” said Shearer.
He added that although the amount of speculative positions in the gold market has increased, not too many people have jumped on the train yet. He sees that institutional and central bank demand will continue to be strong. “At the moment, people are eager to buy and reduce the proportion of currencies in their portfolios,” he said.