1st November 2023  - Gary Mead

Central banks boost gold

Central banks boost gold

Why has gold risen by around 8% (in Dollar terms) in October? Some point to heightened geopolitical tensions but that's only a piece of the story. Signs of inflation slowing are giving rise to feelings that leading central banks - in particular the US Federal Reserve - may have reached the end-point of what has been a long round of interest rate rises. While Christine Lagarde, head of the European Central Bank (ECB), probably spoke for many central bank bosses when she said last week that any chat about cutting interest rates was "totally premature", the ECB held interest rates steady in October, the first time it did so since summer 2022. Some buyers have sought gold for its 'safe haven' properties in the context of the Gaza crisis, worrying that the war could spread; others could well be speculating that interest rates may be turning, and the yields on government bonds could be about to weaken, making gold attractive. October saw a big drop in Eurozone inflation, from 4.3% in September to 2.9%, confounding most economists' expectations, which had anticipated inflation to be above 3%. Natural gas prices in Europe dropped by 10% on Tuesday this week, on forecasts of warmer weather; Europe's inflation was given a shove after February 2022 by the higher energy prices that resulted from the Russian invasion of Ukraine. A decline in gas prices may be short-lived - but every little helps.

Central banks generally aim to get inflation to around 2%/year, which is proving tricky. In some countries and in certain sectors inflation is far, far higher. The Consumer Price Index (CPI) might have been an annualized 6.7% in the UK in September (and 3.7% in the US), but the UK premiums for car insurance - a legal requirement - are now more than 60% higher year on year. The banks' only tool for getting a grip on inflation is to raise interest rates - which they have been doing but with only patchy success.

Moving the goalposts

If you can't score a goal then perhaps move the goalposts. The fragmentation of global trade, kicked off by Covid-19, is proceeding fast, says the World Trade Organization (WTO). The post-1945 international economic order was built on an idealistic vision of increased trade and share prosperity. That vision is under threat. The just-published 2023 edition of the Hinrich-IMD Sustainable Trade Index says the "global trade system is experiencing fragmentation that threatens to erode the achievements of 70 years of globalisation." Thanks to many things - supply chain disruptions, high inflation, conflicts, distrust, resurgent tariff barriers among them - the world has become not just a darker but a more expensive place. Within this gloomier outlook, getting inflation back down to around 2% is going to be tough - so why not loosen the target?

That's the message from the latest annual report of the United Nations Conference on Trade and Development (UNCTAD). It says that central bankers "should relax their 2% inflation target and assume a wider stabilising role...tighter monetary policy has so far contributed little to price easing" but it has contributed a "steep cost in terms of inequality and damaged investment prospects." That certainly seems to be the case in England and Wales, where company insolvencies between July and October were at their highest since the aftermath of the Great Financial Crash in 2009. Corporate defaults and bankruptcy filings in the US have been running at twice the level of 2022.

Multiple explanations

Perhaps the bankruptcies and debt defaults are merely the consequences of the long-delayed popping of the grand money give-away known as Quantitative Easing, which stretched into the Covid epidemic. Once the devil is out of his bottle however it's very difficult to get him back inside - hence the UNCTAD 'relaxation' exhortation. 2% is too difficult, so let it be 3% or even 4%; that's been the gossip in central banking circles for months. The problem for central bankers is that price rises today are not being driven by demand so much as problems with supply. In the US the 'shelter index' portion of the most recent CPI rose by 7.2% year-on-year, and accounted for more than 70% of the total increase in all items, excluding food and fuel. Private rental costs in the UK are currently rising at the fastest pace since records began. The core inflation story in the US, as in the UK, is all about the shortages of supply. Central bankers know how to deal with demand inflation; they don't know how to deal with supply inflation, because its causes lie far outside their control.

If inflation is not dead but just snoozing, or if central bankers are going to relax their inflation target, maybe that helps explain why central banks are loading upon gold reserves - the first nine months of this year have seen central banks buy 800 tonnes according to the World Gold Council (WGC). Another key factor helping to drive higher gold prices is the possibility that interest rates have hit their peak and that if they move any higher then real damage might be done to the economy.

So the gold price has risen not just because conflict has broken out in the Middle East. People are nervous that the conflict might spread; central banks have been big buyers of gold; rumours swirl that central banks might be prepared to tolerate higher inflation targets; and perhaps interest rates have reached a maximum level. All of those factors need to be taken into account when we consider the gold price.