(Kitco News) – A new paradigm shift in the gold market as long-held correlations break down means investors must follow a new playbook, according to one investment firm.
Friday, Incrementum AG released its annual In Gold We Trust report, a more than 400-page report analyzing critical elements of the precious metal. The analysts, led by the firm’s fund managers Ronald-Peter Stöferle and Mark J. Valek, said that structural changes in the global economy have propelled renewed demand for gold as a neutral asset on the world stage.
In a recent interview with Kitco News ahead of the report’s release, Stöferle gave one example of the evolving landscape: the Great Moderation Trade, a period of low inflation that defined global markets in the last two decades, has ended.
“It seems inflation isn’t just transitory but rather pretty sticky. A core piece of the report is that the Great Moderation is over, and inflation volatility will continue to be an important topic. Therefore, we think that makes a solid case for gold,” he said.
Adding to the inflation threat, burgeoning debt worldwide, and geopolitical uncertainty that questions the U.S. dollar’s role as the world’s sole reserve current, as well as physical gold flowing from Western Investors to Eastern investors, are creating new long-term trends in the gold market, the report said.
The Liechtenstein-based fund reiterated its long-term forecast for gold prices to hit $4,800 an ounce in the next six years.
In the interview, Stöferle said that while he sees robust long-term potential for gold, investors should expect periods of volatility as the market carves out elevated ranges. However, some consolidation will not impact the broader landscape.
“The price of gold has risen by almost USD 600 since its lows in October 2023, so profit-taking should come as no surprise,” the analysts said in the report.
According to the report, the most compelling evidence of gold’s new playbook this year has been its unprecedented performance in the face of significant traditional headwinds. Gold prices have surged to record highs above $2,400 an ounce this year as the Federal Reserve has maintained its most aggressive tightening cycle in 40 years.
The gold market has also been able to withstand significant outflows in Western markets. The report noted that more than 760 tonnes of gold have flowed from gold-backed exchange-traded products since April 2022.
“According to the old gold playbook, gold should be at around USD 1,700 in view of the fall in ETF holdings,” the analysts said.
The analysts said that the growing influence of emerging market central bank demand and robust retail demand in key markets like China and India have pushed Western investment demand to the background.
“The reorganization of the international economic and power structure, the dominant influence of the emerging markets on the gold market, the reaching of the limits of debt sustainability, and possibly multiple waves of inflation are causing gold to appreciate. This phase will continue for some time, until a new equilibrium has been established.
The analysts said that central banks have become a decisive factor for gold, creating a floor in the marketplace. According to the report under the new playbook, central banks are looking for a neutral asset as they move away from the U.S. dollar and bonds.
“The uniqueness of gold as a neutral reserve currency without counterparty risk is now being rediscovered. The structural increase in central bank demand is a key piece of the new playbook, mainly because central bank demand is relatively less price sensitive,” the analysts said. “For state actors such as central banks and sovereign wealth funds, gold is increasingly becoming the golden queen on the geo-economic chessboard.”
At the same time, retail investors in emerging markets, specifically China, have become significant gold buyers. The report noted that in the last five years, 70% of physical gold demand has come from emerging markets, with more than half of that consumption coming from China and India.
Chinese investment demand has increased this past year as investors, holding record savings, face a shrinking pool of liquid investment opportunities, the analysts said.
“Now that the Chinese real estate market, traditionally used for retirement provision, has hit turbulence, there is a substantial need for alternatives,” the analysts said.
Although Western investors have been reluctant to acknowledge gold’s new playbook as they focus on elevated opportunity costs, Incrementum said that they expect it will only be a matter of time before this trend shifts. The analysts said they expect that growing government debt will continue to weigh on the bond market, ending the traditional 60/40 portfolio allocation.
“In an age of immanent over-indebtedness and therefore a permanent latent risk of inflation, there is one big loser among all asset classes: bonds,” the analysts said.
In this new era, Incrementum said investors should consider a more balanced portfolio, including holding up to 25% in physical gold bars and coins.
“Given our skepticism towards government bonds, we assume that an increasing number of market participants will consider a higher weighting of both safe-haven gold and performance gold in the future,” the analysts said. “Specifically, in a portfolio with a longer-term investment horizon, we consider a ratio of up to 15% safe-haven gold and up to 10% performance gold to be advisable. Safe-haven gold is a fail-safe, liquid asset that is mainly used to hedge against economic and (geo) political instability, high inflation, and worstcase scenarios,” the analysts added.
While the fund sees long-term potential for gold, the analysts also highlighted some risks, including higher for longer interest rates, and a potential crash in the stock market that creates a liquidity event, weighing on gold and easing geopolitical tensions.
