To The Moon

Since mid-September, domestic and foreign gold prices have repeatedly hit record highs, exceeding US $2,600/oz, continuing the strong bull market since the fourth quarter of last year. As of September 17, the COMEX gold December contract has increased by more than 20% annually (see the chart below), and the full-year increase in 2023 is only 9.8%. This is also the third consecutive year of increase since 2022.

The Federal Reserve announced a 50 basis point interest rate cut, which is an important node for gold prices. In the short term, we need to pay attention to the risk of callback after the interest rate cut is favorable. However, in the long run, after the Federal Reserve cut interest rates, the decline in the real interest rate of the U.S. dollar stimulated the rise in investment demand, superimposed on the long-term benefits of the central bank's gold purchase to hedge against the weakening of the U.S. dollar credit. The bull market of gold is not over yet and is expected to hit a record high again.

Fed cuts interest rates by 50 basis points

From the perspective of economic indicators, in the second quarter of 2024, the U.S. GDP rebounded to an annualized rate of 3% month-on-month, and there was no recession. Lagging indicators, such as the unemployment rate triggering Sam's law, and personal consumption expenditures, show that the U.S. economy slowed down in the third quarter, but has not yet entered a recession.

However, the risk of a U.S. economic recession has not been ruled out, especially the rebound in the unemployment rate. In order to prevent the economy from turning from slowdown to recession in advance, the Federal Reserve is likely to launch a preventive interest rate cut in September. According to the yield curve, we find that the 3M-10Y yield inversion structure has not been reversed, and the spread as of September 13 is 1.31 percentage points. According to the historical scale, there is a high probability that the U.S. economy will experience a recession six months to one year after the yield curve is inverted, as high interest rates restrain economic activity.

Private sector consumption, which makes an important contribution to the U.S. economy, is likely to experience negative growth in the fourth quarter. Looking back at the path of U.S. economic recovery after COVID-19 pandemic in 2020, the government's use of large-scale fiscal subsidies to prevent the balance sheet of the residential sector from declining is the key to U.S. economic recovery. Excess savings have caused the consumption of American households to continue to increase substantially, which has a significant effect on boosting GDP. In 2024, as excess savings are exhausted, residents will have insufficient consumption stamina. In the second quarter, the personal savings rate of U.S. residents fell to 3.3%, and once climbed to 26.4% in the second quarter of 2020. The premise of maintaining the growth of consumption expenditure is that disposable income maintains the rapid growth. This year, the year-on-year growth rate of personal real disposable income of American residents has continued to slow down. On the one hand, wage growth has slowed down; On the other hand, there is the erosive effect of inflation. In July, the actual disposable income of American residents increased by 0.11% month-on-month, and it is likely to fall into negative growth in the future. Data released by the U.S. Census Bureau showed that U.S. retail sales increased by 0.1% month-on-month in August. Although it was better than the expected decline of 0.2%, it was lower than the adjusted 1.1% in July.

Although there is no risk of U.S. economic recession at present, all previous U.S. recessions have come from private sector deleveraging. Once there is real estate shrinkage and destocking resonance, large-scale private sector deleveraging will lead to a recession in the U.S. economy. The risks of U.S. economic recession come from two sources: First, U.S. stocks continue to plummet, triggering a recession in the balance sheet of the private sector, because stocks account for a high proportion of residents' assets, approaching 18%, which is higher than the record when the Internet bubble burst in 2001; The second is public debt default, which is very unlikely due to the monetization of U.S. debt and the U.S. government's dilution of debt through inflation.

Investment demand is returning

Looking back at the gold bull market stage from the second half of 2022 to the present, the demand for gold investment is absent. The investment demand for gold in the first quarter of 2009, the second quarter of 2010, and the first quarter of 2016 all exceeded 600 tons, but this round of gold prices hit a record high, and the investment demand was only about 300 tons. Statistical historical data show that the price of gold shows a moderate positive correlation with the investment demand of gold, and in turn shows a moderate negative correlation with industrial demand and jewelry demand, which is different from investors' intuition.

The leading indicator of investment demand is the real interest rate of the US dollar, because the real interest rate of the US dollar can be regarded as the opportunity cost of investing in gold. The lower the opportunity cost, the more cost-effective gold investment is. Against the background of the slowdown of the U.S. economy and the interest rate cut by the Federal Reserve, the real interest rate of the U.S. dollar is declining, which means that investment demand will return in the future, and the benefit of succeeding the central bank's gold purchase will once again drive the price of gold up. On September 16, the 10-year TIPS yield, which represents the real interest rate of the US dollar, fell to 1.54%, the lowest since July 27, 23. At the same time, the gold holdings of SPDR, the world's largest gold ETF that reflects gold investment demand, increased significantly in mid-to-early September, rising to 872.63 tons as of September 16, after hitting a year low of 815.13 tons in March, compared with 880.27 tons in the same period last year.

The picture shows the comparison of gold investment demand and COMEX gold price trend

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Central bank gold purchases continue to fuel gold demand

In recent years, although the U.S. economy has recovered from the epidemic and remained resilient, the main reason is large-scale fiscal expansion. In order to cooperate with the fiscal expansion, the U.S. Treasury Department has issued large-scale bonds, and the U.S. public debt is high, resulting in damage to the credit of the U.S. dollar. In addition, with the decline of the comprehensive strength of the United States in politics, economy, science and technology, the proportion of the US dollar in global foreign exchange reserves has been declining, and countries have made diversified allocations. As of the first quarter of 2024, the proportion of the US dollar in international foreign exchange reserves has dropped to 58.9%, compared with about 70% when the Bretton Woods system was established in the 1970s.

In the demand for gold, the proportion of gold purchased by the central bank has risen sharply in the past three years, which can explain why the demand for gold investment has not increased significantly and the price of gold has risen sharply in the past three years. Data released by the World Gold Council shows that in the first quarter of 2024, global central banks purchased approximately 286.2 tons of gold, higher than 173.6 tons in the fourth quarter of last year. Central banks bought 483 tonnes of gold in the first half of 2024, setting a new record.

To sum up, after the Fed cuts interest rates, the short-term gold market may experience a correction due to the market psychology of "buying expectations and selling realities". However, in the medium and long term, the Fed's interest rate cut means that the global monetary policy has officially turned loose, and the downward trend of the real interest rate of the US dollar is expected to accelerate, which will stimulate the return of investment demand. Considering the weakening of the credit of the US dollar, the purchase of gold by central banks is a long-term activity, and the gold bull market will continue to advance.

Investors can pay attention to CME group's US dollar-denominated micro-gold futures (MGC) in order to obtain the benefits brought by rising gold prices or hedge the risk of rising gold purchasing costs. The size of the CME group micro gold futures contract is 1/10 of the 100-ounce gold futures contract, and its contract unit is 10 troy ounces. In August, COMEX gold active contracts hit a record high of $2,550.60 per ounce for the second consecutive month, and the net position of funds under management has reached 200,000 contracts, the highest level since January 2020 (see chart below).

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