What’s Going on with Gold?

By Giles Coghlan, Chief Market Analyst consulting for HYCM

Gold’s performance has been confounding investors for several years now. After setting a new all-time high against the US dollar in those early months of the pandemic, it has since taken a back seat to the fervent speculation in risk assets (most notably crypto) throughout 2021 and failed to perform as advertised during the worst of the inflation we experienced globally in 2022.

It has performed reasonably well at preserving wealth when the price is in currencies other than USD, but it still hasn’t really provided the kind of gains that gold bugs had been predicting would occur when global macro events line up in the manner we’ve observed since 2020.

Now, with inflation appearing to peak and the Fed presumably closer to the end of its tightening cycle than it is to the beginning, we find ourselves in the midst of a gold rally that has seen the yellow metal appreciating by almost 20% against the US dollar since November of last year. So, quite rightly, the question many traders are asking at the moment is, what’s going on with gold?

Bretton Woods III?

Early in 2022, just as the globe was getting to grips with Putin’s war in Ukraine, Zoltan Pozsar, Head of Short-Term Interest Rate Strategy at Credit Suisse, published a note in which he stated that the crisis “is not like anything we have seen since President Nixon took the U.S. dollar off gold in 1971.”

He likened the consequences of the massive global events taking place to a Bretton Woods III. If Bretton Woods I described an era backed by gold bullion, and Bretton Woods II was the era backed by the “inside money” of Treasuries, with confiscation risks for states deemed to be acting beyond the pale of Western ideals, then Bretton Woods III would again be backed by the “outside money” of gold bullion and other commodities that can’t be subject to seizures as in the case of the G7 and Russia’s FX reserves.

The Dawn of the Petro-Yuan

In December of last year, President Xi Jinping met with Saudi and Gulf Co-operation Council leaders in order to broker a deal that would see the world’s second-largest oil producer and largest oil exporter, selling oil to China, the world’s largest consumer of energy, in renminbi rather than in US dollars.

This new alliance could prove to be as monumental as the one made by US president Franklin Delano Roosevelt when he met with Saudi King Abdul Aziz Ibn Saud in 1945 on the USS Quincy to guarantee Saudi Arabian security in exchange for crude oil priced in US dollars.

That earlier meeting was the birth of what has come to be known as the petrodollar and is one of the lynchpins of the US dollar’s reserve currency status. In a more recent note, Pozsar concluded by boiling the situation down as follows: “GCC oil flowing east + renminbi invoicing = the dawn of the petro-yuan.”

Not Such a Barbarous Relic, After All

In a recent paper by Chi Lo, Senior Market Strategist APAC of BNP Paribas Asset Management, he outlines how China’s gold reserves are crucial to its ambitions of providing an alternative on the global markets to the US dollar.

“Of course, the petro-yuan will not displace the petro-dollar and the dollar-based payments system overnight. However, China’s strategy to back renminbi oil trades by gold is instrumental in building up the petro-yuan system. Making the renminbi convertible into gold effectively turns the currency into a global investable asset for foreign renminbi owners, boosting their confidence in and demand for the Chinese currency.” He goes on to state that: “Sustaining and growing the petro-yuan network also means that China would have to accumulate more gold for a gold-backed renminbi.“

Back in November, the World Gold Council reported that central banks had purchased four times the amount of gold in Q3 of 2022 than a year earlier. According to their data, up until September central banks had purchased more gold in 2022 than in any previous year going back to 1967, when the US dollar was still backed by gold.

China, though rarely transparent about its gold purchases, was said to have purchased 902 tons up until September, beating its 2021 and 2020 totals with three months left to go. Many are associating the rise in central bank purchases of gold with a rush to stock up on alternatives to US dollar reserves, particularly after the United States has demonstrated its ability to sanction central bank reserves.

A Multi-Year Bull Market?

It’s easy for younger generations to forget that money used to be backed by tangible assets. And that after this was no longer the case in the fiat money era, the world’s reserve currency was backed by the full faith and credit of the US government, bolstered by its strategic alliances that maintained the petrodollar system.

As that full faith and credit are thrown into question in a multipolar world of shifting allegiances, could gold emerge once again as the underlying commodity that backs the money of a new era and builds trust where needed? The last time the global economy went through a shift like this, gold was trading below $50 per ounce, then post-Nixon-shock it rallied to a high of over $650 per ounce. It’s certainly a sobering thought, especially after so many pointed to gold’s recent performance as evidence that it was dead as a macro asset.

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