Gold has always been a fascinating asset for both analysts and investors.
The wide range of answers you'll get when asking what truly drives gold’s price movements is a theme in itself. In this analysis, we explore two crucial drivers that indicate a bullish outlook for gold prices ahead of 2025:
- Rising inflation expectations.
- Steady central bank purchasing.
Contrary to popular belief, these are the forces that most influence gold, not recession fears or economic contractions.
Let's verify the data and understand why the future for gold looks increasingly golden. A bullish gold price prediction seems like a no-brainer conclusion. However, we prefer to let the data speak for itself, and avoid any form of bias.
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Common Misconceptions About Gold Price Drivers
Before examining the current data points in the gold market, we need to address three common misconceptions:
- Gold Performs Best in Recessionary Environments: Many believe gold thrives primarily as a "fear asset" during economic downturns. However, data shows that gold performs well when inflation expectations are rising, which often coincides with bullish stock market trends.
- Central Bank Buying Doesn't Affect Prices: Another misconception is that central banks, being less price-sensitive, do not influence gold prices. The truth is, central banks' substantial and sustained purchasing creates a strong underlying support for gold prices.
- Gold’s Fundamentals Are Tied to Economic Growth: Contrary to the belief that gold's price is fundamentally tied to economic growth metrics, the reality is that gold's primary driver is inflation expectations, particularly as measured by real interest rates adjusted for inflation.
These misconceptions have misled many investors about the true dynamics influencing gold prices. Understanding the data and key drivers, such as inflation expectations and central bank activity, is essential for making informed decisions.
The Real Gold Price Influencer: Inflation Expectations
While many analysts mistakenly focus on economic slowdowns as the primary triggers for gold's performance, the data tells a different story. The most significant driver of gold prices is inflation expectations, which have been steadily rising. This is excellent news for gold investors because there is a strong correlation between inflation expectations and gold prices.
Fundamental Support in the Gold Market: Central Bank Buying
Central bank purchasing has been playing a pivotal role in recent years.
Contrary to common belief, central bank purchasing was not a fundamentally important influencer of price in the past.
This is evidenced by the following chart depicting physical gold (in tonnes) held as reserves by central banks worldwide compared to the price of gold:
This structural shift began between 2019 and 2021, when the proportion of physical gold in central bank reserves started increasing:
The importance of this buying activity cannot be underestimated. As explained in the latest edition of In Gold We Trust, the most extensive and detailed gold market research:
“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. One could say that central banks have put a floor under the gold price.”
Central Bank Buying: The Latest Data
The latest data from July 2024 reveals that net gold purchases by central banks more than doubled to 37 tons, a 206% month-over-month increase.
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This marked the highest monthly total since January 2024, indicating strong demand from central banks. The evolution of net purchases by central banks says it all:
Quoting again from In Gold We Trust 2024:
“The renaissance of gold is also reflected in the fact that the World Bank published a ‘Gold Investing Handbook for Asset Managers’ at the end of February. It explicitly cites several studies that impressively confirm the properties of gold as a diversifier, particularly in the event of downward volatility. Central banks are recommended to hold up to 22% gold.”
Gold’s Fundamental Price Driver: Inflation Expectations
When discussing gold's fundamental drivers, it's crucial to understand the role of inflation expectations. Inflation expectations, particularly when represented by the TIP ETF (an ETF that tracks inflation-protected securities), show a strong correlation with gold prices:
It is evident that gold bull markets over the past 20 years have coincided with rising TIP ETF levels.
This connection is clear in the price movements of gold alongside inflation expectations and major stock indexes like the S&P 500. The data could not be clearer: as inflation expectations rise, so does the price of gold.
In stable financial markets, gold tends to thrive when inflation expectations are climbing. This contradicts the common belief that gold only does well during market turmoil or in fear-driven environments. The evidence shows that gold's performance is more about rising inflation expectations and less about economic recessions.
Conclusion
The outlook for gold remains very bullish as we approach 2025, driven by two key factors:
- Rising inflation expectations.
- Robust central bank demand.
By debunking common misconceptions and analyzing the actual data, it becomes clear that the gold market is in the midst of a secular bull phase.
With inflation expectations continuing to rise and central banks increasing their gold reserves, the fundamentals supporting gold prices have never been stronger.
Investors looking to understand the dynamics of the gold market should focus on these critical drivers rather than outdated notions of recession fears or economic growth indicators.