The price of gold has soared recently, especially in Asia, where it has hit record highs. At the end of August, the retail price of gold in Japan exceeded 10,000 yen/gram for the first time in history, with a cumulative increase of 17.7% since the beginning of the year. Gold prices in Shanghai also hit a record high. what happened?
Gold prices hit new high in Asia
Although the U.S. dollar index has continued to strengthen since August, approaching a new high for the year, and real interest rates have also risen rapidly during the same period, the price of gold has remained strong, with a 6% increase so far this year.
Since gold is an interest-free asset, the real interest rate determines the opportunity cost of holding gold. Therefore, there is a relatively stable negative correlation between the real interest rate and the price of gold. The real interest rate has been an important pricing reference for gold for a long time in the past.
But in fact, since the second half of 2022, as inflation has peaked and the U.S. economy has maintained resilience, real interest rates have gradually emerged from the negative range. However, at this stage when inflation expectations are falling and real interest rates are rising, the price of gold has not been significantly suppressed by the rapid rise in real interest rates and the strength of the U.S. dollar.
Recently, gold prices in Asia have hit record highs.
According to data from Tanaka Kikinzoku Kogyo, Japan's largest gold retailer, the retail price of gold in Japan (including consumption tax and storage fees) exceeded 10,000 yen/gram for the first time in history at the end of August, with a cumulative increase of 17.7% since the beginning of the year.
Domestically, the closing price of Au9999 on the Shanghai Gold Exchange rose to 468 yuan/gram, also setting a record high. Even though London gold has experienced a round of adjustments since late July, Shanghai gold has continued to strengthen.
For a long time, as a net importer of gold, the domestic spot gold price has maintained a certain premium relative to the international gold price, reflecting the costs of air transportation, insurance, conversion or manufacturing costs, customs clearance and the entry and exit of the Shanghai Gold Exchange.
At the same time, in order to maintain market stability, the country has certain controls on gold imports, which also makes the "scarcity" of domestic gold higher than that of other markets. Coupled with the impact of import costs, gold premiums arise accordingly.
Since August, the Shanghai-London gold price has risen rapidly. The average premium in September reached 53.4 US dollars per ounce, almost three times that of July, setting a record high.
In addition to Japan and China's gold prices reaching new highs, Australian gold prices also rose to 2,988 Australian dollars per ounce, an increase of more than 11% during the year, which also significantly exceeded the increase in the international gold price in US dollars.
Exchange rate fluctuations trigger gold price differentials
Based on the World Gold Council's pricing model, approximately 9% of gold price fluctuations in the first half of this year cannot be explained by conventional interest rates, foreign exchange and risk factors. The World Gold Council attributes this to central bank purchases and event risk premiums.
Data source: World Gold Council, ECON=economic expansion, RISK=risk and uncertainty, OCFX=opportunity cost of foreign exchange, OCIR=opportunity cost of interest rates, MOMPOS=momentum and trends
Net purchases of gold by global central banks will reach 1,081.6 tons in 2022, and net purchases from January to July this year have also reached 442 tons. In comparison, the average annual net purchases by global central banks from 2010 to 2021 were approximately 470 tons.
Chart: Global central banks have actively increased their gold holdings since 2022
China has increased its gold holdings for nine consecutive months, adding a total of 188 tons of gold reserves. Other major buyers include Singapore, Poland, India, etc.
Chart: Central bank demand for gold continued to hit a record high in the first half of this year
Data source: World Gold Council
The world is experiencing the challenges of geopolitics and changes in the international monetary system. Gold, as a safe-haven asset, has once again demonstrated its allocation value. Global investors represented by central banks continue to buck the trend and increase their holdings of gold, which overall supports the price of gold.
In different regions, similar to crude oil, retail prices are more or less different, which is mainly affected by factors such as warehousing, local taxes, and currency exchange.
Most of the countries mentioned above that have seen a sharp rise in gold prices and experienced a premium between domestic gold prices and international gold prices have experienced depreciation of their currencies against the US dollar this year.
Since the beginning of this year, the Japanese yen has depreciated nearly 11% against the US dollar, once falling below the 147 mark, which has promoted the strengthening of Japanese gold prices denominated in Japanese yen. Among other currencies, the yuan fell to 7.3 against the US dollar, and the Australian dollar depreciated nearly 6% against the US dollar. This year, the Swiss franc and sterling-denominated gold investment returns, which have strengthened relative to the US dollar, have been lower than the US dollar-denominated gold price.
Figure: Exchange rate fluctuations have affected the price of gold in different markets and the corresponding investment returns in different markets this year.
Data source: goldprice.org
Gold prices imply depreciation expectations
The differences in gold prices across countries reflect the monetary attributes of gold. During the period of significant exchange rate fluctuations, gold can meet investors' needs for hedging and value preservation in foreign exchange.
Data from the World Gold Council shows that in anticipation of higher U.S. bond interest rates, global gold ETFs have shown a net outflow pattern this year. In August, global gold ETFs experienced net outflows for the third consecutive month, with an outflow of US$2.5 billion in August, resulting in a 3% drop in total asset management to US$209 billion, and a decrease in holdings of 46 tons to 3,341 tons.
However, with continued outflows from North America and Europe, Asia bucked the trend and saw inflows. This year, Asian gold ETFs recorded net inflows for six consecutive months, with an inflow of US$430 million in August. The price difference attracted some investors to the Asian market.
Chart: Gold ETF flows
A review of historical trends shows that when the local currency depreciation is expected to be strong, the premium of gold within the market is often higher, and vice versa. Therefore, the price difference between gold's internal and external prices can also be used as a reference for observing expected changes in market exchange rates and monetary policy.
Further based on the interest rates implied by the domestic and foreign gold price ratios, the yield spread between China and the United States on 10-year treasury bonds is about 1.7 percentage points.
With the Federal Reserve maintaining high interest rates and the U.S. economy remaining resilient, the U.S. dollar index remains strong, putting pressure on international gold prices. At the same time, the strength of the U.S. dollar continues to put pressure on non-U.S. currencies. Under the influence of exchange rate factors, gold's internal and external price differences may continue to deviate from the normal fluctuation range in the past.