Is gold’s frenzied rally finally winding down?

One, gold’s parabolic valuation increase comes at a time when other markets are also simultaneously surging – shares, crypto, meme stocks, benchmark currencies, etc. In fact, such has been the pace of this rally that gold has outperformed stocks in what is decidedly a bull market in the US, driven by turbocharged AI optimism.

According to analysts, there are other correlations worth considering: while gold is up 60 per cent this year, crude oil is down 20 per cent or so. The gap works out to around 80 per cent, which analysts say is the most in at least a hundred years. The most recent instance when such a varied movement was seen is 2008, when the disparity was about 60 per cent – gold was up nearly 10 per cent while crude oil was down about 50 per cent. This year’s trend beats even that.

The recent surge in gold prices also comes at a time when the US dollar has strengthened against major peers, including the Euro and the Japanese Yen in the past month, following better than expected US economic data.

Now, the irony here is that gold is seen as the ultimate safe haven asset, a time-tested store of value. Typically, it goes up when everything else underperforms. This time around, the gold rally has unfolded when most other assets – stocks, crypto and the US dollar (in recent weeks) – have also been on the up.

Silver has tagged along too, both because gold generally has a trailing impact on silver and also due to silver’s increased industrial application. “Gold is surging on the same day that US stock indices have (risen) over 1 per cent. This simultaneous climb in both a classic safe haven and risk assets is a powerful illustration that the drivers of the current gold rally are different from historical patterns,” Mohamed A. El-Erian, Rene M Kern Professor at the Wharton School, shared in a post on October 20.

The triggers

So, what explains this simultaneous climb by the ultimate safe haven asset and other risky ones? To answer that, it might be worth going back to when the gold rally started in the first place.

The original trigger came over three years ago, following the sanctions the US imposed on Russia after it invaded Ukraine. After that, central banks around the world, led by China and to some extent India, started diversifying their foreign exchange reserves, which are usually heavily dominated in assets denominated in the US dollar. Gold was the obvious choice, and that led to increased gold buying by central banks as they tried diversifying away from the greenback. That led to a slow, but steady, climb in the value of gold.

But the current gold rally, which has been playing out over the last few months, has a somewhat different trigger: a lot of Exchange Traded Funds (or Gold ETFs) buying across the world. Gold ETFs are essentially open-ended mutual fund schemes that are based on gold prices and are traded on stock exchanges. But for every ETF unit bought, there has to be some physical gold stashed away as backup, leading to a higher demand for the physical metal that goes in tandem with ETFs. This triggers a general demand-price increase.

Consider the example of India: money in gold ETFs in September was nearly seven times higher compared to the same month last year at Rs 8,363 crore.

According to Ruchir Sharma, the head of Rockefeller Capital Management’s international business, the gold ETFs floated in the last quarter were the highest ever, and much of this buying is happening on account of the liquidity that is sloshing around the system. This includes the legacy liquidity, which was the result of the quantitative easing initiated by western governments after the pandemic. What is different, though, is that this liquidity is now driving speculative frenzy – including, ironically, in a safe haven asset: gold.

A pause

Coming back to the original question: is it the end of this rally? Not really. Most market players are coming around to the view that the rally will continue after a profit booking stint and when these overheating concerns abate.

That’s because the appeal of gold as a safe haven continues, given the factors such as central banks’ stance and prevailing uncertainties – monetary authorities around the world are likely to continue with their liberal stance on liquidity and policy rates for now, with Donald Trump’s tariff onslaught and the continuing Russia-Ukraine war posing risks. America’s spending bill and debt overhang, slowdown in China, among other factors, are also concerns which increase the appeal of gold.

There is one more generic factor in play: the supply of gold is increasing very slowly, at around 1.5 per cent a year, since mining is limited. That’s been the rate for more than half a century. The supply of dollars goes up by 6-8 per cent per year, in comparison. So, there is a supply-driven reason for the gold prices staying up for longer too.

Also, Goldman Sachs, in a September note, indicated that if Trump were to go after the US Federal Reserve’s independence, gold could surge as people might run from the dollar and seek safe haven assets such as gold. If the Fed does not cut rates further, it could inevitably come under further fire from Trump.

What could conclusively impact the gold rally in a major way, or at least the liquidity driven part of the rally, is if inflation were to come back in a big way. This would force the US Fed to withdraw some of this liquidity, which could dent part of the appeal of gold. But, on the flip side, that could also upend the stock rally – and in the process increase gold’s appeal as a safe haven asset.

So, the gold’s northward streak could continue for longer.