Dollar dive and vol spike drove gold up 

Gold continued its ascent in April, breaking the US$3,500/oz mark in intra-day  trading during the month.¹ While gold pulled back from its record highs, it still  finished strong, above US$3,300/oz and rising by 6% m/m (Table 1, p2). Gold’s  return was more modest in developed market currencies and even fell slightly in  Swiss francs on the back of local currency strength versus the dollar.  

In fact, our Gold Return Attribution Model (GRAM) points to the significant  plunge in the US dollar – captured by ‘opportunity cost (FX)’ – as one of the key  drivers of gold’s performance in April (Chart 1). Other contributing factors were  a spike in market volatility and geopolitical concerns (‘risk and uncertainty’). The  model also suggests that there was a degree of mean reversion that created a  drag on gold’s performance, as some investors likely took profits following four  consecutive months of strong returns (‘momentum’).  

A significantly weaker US dollar  and overall heightened risk pushed  gold higher during the month. 

Looking forward 

We expect US policy and structural inflation risk to continue driving  gold investment. Profit taking  could bring pause but may also encourage consumers.

Can gold’s run last? 

Gold is up by nearly 27% y-t-d, significantly outperforming  major asset classes.Not surprisingly, investors are asking what’s behind the move and how sustainable it might be.  

Gold has been supported by a combination of:  

• US trade policy uncertainty and, more generally,  geoeconomic risk 

• A weakening US dollar  

• Higher inflation expectations combined with lower bond  yields  

• Continued central bank demand. 

Against this backdrop, investment flows via gold ETFs have  significantly ramped up. In Q1,gold ETFs amassed US$21bn  of inflows – the strongest quarter in three years – with an  additional US$11bn in April. Collectively, US funds have led  the way, but Chinese funds have increased their holdings by  a whopping 77% y-t-d.  

Early innings? 

Does this mean that the gold investment market is becoming saturated? We don’t believe that’s the case. Previous gold bull runs have coincided with significant  inflows in gold ETFs. But there seems to be room to grow.  

Risk by any other name…is still risk 

Investors have grown increasingly concerned over the  growth and inflation outlook from the fallout of the ongoing  trade war, both in the US and globally The rise in  uncertainty around trade policy and international relations  has been supportive of gold as investors typically turn towards safe-haven assets for downside protection in those  types of environments.  

This has been exacerbated by pressure on US Treasuries  and the dollar, which traditionally function as safe havens.  This phenomenon is well documented by the media.In  addition, conversations with wealth managers suggest that,  for the first time in a long time, many investors have been  seeking to hedge their overexposure to US dollar assets. 

We estimate that trade concerns have accounted for  approximately 10% to 15% of gold’s return y-t-d,  stemming from USD devaluation, heightened geopolitical  and market risk, and at least partly from some of the  investment flows we’ve seen in recent weeks.  

However, even if trade negotiations were to progress and  conditions to improve, we would not expect gold to  completely reverse its risk-induced bump.  

The Fed has become a little more dovish recently. According  to the Fedspeak Index, the FOMC is now very much on the  fence as it balances the need to control inflation with  supporting slowing growth.

Focusing on the ‘real’ side of real rates A major concern regarding US trade policies is the potential  effect they could have on US and global inflation. Indeed,  short-term inflation is expected to rise in the US according to  consumers and market measures

Generally, high inflation is supportive for gold as investors  seek out real assets for protection amidst falling purchasing  power. Inflation, however, is often accompanied by higher  rates that may create a drag on performance. 

For one, gold remains well bid despite some easing of trade  tensions and the noteworthy rebound in the US stock market since early April. In addition, investors – especially  international ones – appear wary of policies on which the Trump administration may concentrate next…and all other  policies that may come over the following three and a half years.

Even if the Fed were to turn more hawkish, which we believe  would only occur in the event of longer-lasting inflation  effects, gold could remain supported.  

Using GRAM, we have analyzed the effect that changes in inflation and yields can have on gold, holding other variables  constant. The main conclusion is that, in this environment, a  rise in inflation will likely have a more positive effect on gold’s  performance than the potential drag that higher rates may  bring .  

The positive effect of rising inflation on gold in  the current environment may overcome a possible drag  from interest rates .Hypothetical effect on gold’s return from changes in inflation  and interest rates holding other drivers constant* 

While investment flows are the key driver of large gold price  movements, consumers are an important contributor to  gold’s performance in the medium and long term. And they  are key to sustaining gold trends. Higher gold prices have  been deterring some jewellery buyers and while consumers  can adjust to higher price levels, they still need time to adapt. 

At present, recycling has remained surprisingly muted, but deteriorating economic conditions could change this,  bringing additional supply and adding pressure to gold. 

Central banks have also been an important source of  demand for the past three years, significantly contributing to  gold’s performance. We still expect central bank demand to  remain robust this year, but rapidly rising prices have, in the  past, temporarily decelerated purchases.

Looking beyond investors 

We have covered multiple reasons why gold investment may  remain strong. However, it is important to consider potential  headwinds.  We believe that structural reasons will enable investment  demand to continue to thrive:

• Uncertainty surrounding US policies and their effect on  the dollar 

• More sensitivity to higher inflation expectations and a  higher likelihood of lower interest rates 

• Lower gold accumulation levels than in previous cycles.

That, of course, would not prevent potential pullbacks driven  by profit taking or signs of advancements in trade  negotiations. 

Equally, for gold’s bull run to be sustainable for longer,  consumers need to be given time to adapt to higher prices.