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Are gold prices now too high?

Gold prices remain within touching distance of the all-time highs of $2,510 set recently amid ongoing geopolitical tensions.
The precious metal is up around 20% year-to-date outperforming most other asset classes.
WHY HAS GOLD HIT NEW HIGHS
It is not hard to see why investors have flocked to gold due to the crises in the Middle East, the ongoing Russia-Ukraine war, worries about expected interest rate cuts and stock market volatility.
Gold is often seen by investors as a ‘safe haven’ asset which can hold its value during periods of volatility and economic downturn.
According to the World Gold Council’s second-quarter gold demand trends report, total global gold demand increased 4% year-on-year to 1,258 tonnes.
Central banks and official institutions have increased their global gold holdings by 183 tonnes slowing down from the previous quarter but still reflecting a 6% increase year-on-year.
The World Gold Council remains bullish on the precious metal for the next 12 months as investors strive for portfolio protection and diversification ‘in a complex economic and geopolitical environment’. Total demand was supported by healthy OTC (over the counter) transactions, up 53% year-on-year at 329 tonnes.
OUTLINING THE BULL CASE FOR GOLD
US investment bank JP Morgan (JPM:NYSE) expects gold prices to average $2,500 per ounce in the fourth quarter of 2024 due to heightened geopolitical risks, expectations the Fed will begin lowering interest rates and central bank buying.
Gregory Shearer, head of base and precious metals strategy at JP Morgan says that gold’s resurgence has come earlier than expected as it further decouples from ‘real’ (inflation-adjusted) yields or interest rates. Typically, gold prices trade in inverse correlation to real rates.
‘We have been structurally bullish gold since the fourth quarter of 2022 and with gold prices surging past $2,400 in April, the rally has come earlier and has been much sharper than expected,’ Shearer says.
‘It has been especially surprising given that it has coincided with Fed rate cuts being priced out and US real yields moving higher due to stronger labour and inflation data in the US.’
The cheapest and simplest way for investors to buy gold is through ETPs (exchange-traded products).
Global gold ETPs experienced their strongest month since April 2022 in July, attracting inflows of $3.7 billion, the third consecutive monthly inflow, according to the World Gold Council. Recent inflows and the rising gold price have pushed global gold ETFs’ total AUM (assets under management) to $246 billion.
BEAR CASE FOR GOLD
However, some analysts believe the outlook for gold is not rosy for the rest of the year. RBC Capital Markets analysts have maintained a cautious stance ever since the precious metal hit record highs: ‘We think that gold is overvalued from the perspective of a few key macro drivers and that there are some unrealised vulnerabilities to the pillars of gold’s rally. While we are cautious, it’s more because we do not think gold should be at such high levels just yet.’
The World Gold Council noted in its recent second-quarter report profit-taking in some markets and lower levels of net demand in Europe and North America.
RBC also notes that while May and June saw more stable trends for ETPs (gold-backed exchange-traded products), it remains unconvinced that investors are fully committed.
Investors have sold gold holdings during the price rally, and a sustained return to buying has not yet been observed.’
Strong demand from global central banks has been a crucial driver of gold’s recent rally. However, RBC analysts believe that China’s recent pause in gold buying reveals potential vulnerabilities.
‘To be clear, we still think that central bank demand will continue to be strong, but there are reasons to be cautious on the volume at record prices and after such a sustained period of strength.’
A LONG-TERM VIEW
Published in May, a piece of research from former commodity fund manager Claude Erb and Campbell Harvey – a Duke University finance professor – suggests gold will lag US inflation by more than 7% a year over the next decade.
The authors observe that, historically, a high inflation-adjusted gold price has been associated with low inflation-adjusted returns from the precious metal over the subsequent decade.
Posing the question: ‘Has an influx of gold buying ushered in a new age of permanently higher “this time is different” real gold prices or is this simply the latest “wash, rinse, repeat” cycle setting-up a significant fall in real gold prices?’
What lends their scepticism about gold some credence is a report they published in 2012 proposing a so-called ‘fair value’ for gold which suggested gold was heavily overvalued at the time. From its 2012 high gold dropped more than 40% in real terms to its 2015 low.
Key events in the US political and financial calendar lie ahead including: the Democratic National Convention, the US presidential election and US Federal Reserve meetings which might shape the future price of the precious metal.
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