First official purchase in 3 years.

Is an upward movement in gold anticipated?

In November, a frenzy occurred in precious metals circles when analysts reported that a "mystery" buyer had purchased some 300 tonnes of gold, roughly three-quarters of what would be a record 399 tonnes of gold purchases by a central bank in the third quarter.

 

 

Here again is the big picture: central banks bought 399.3 net tons of gold in the July-September period, more than quadrupling on the year, according to the November report issued by the World Gold Council. The latest amount marks a sharp jump from 186 tonnes in the previous quarter and 87.7 tonnes in the first quarter, while the year-to-date total exceeds any full year since 1967.

Buyers such as the central banks of Turkey, Uzbekistan and India reported purchases of 31.2 tons, 26.1 tons and 17.5 tons, respectively, all as of the close of September, as with an update by the World Gold Council in January 2023 with information as of the close of November, it makes it clear that certain buyer countries became sellers but most notably, China and Russia appear on the scene with massive purchases in a single month:

 

 

And quoting analysts, they go on to suggest that seeing how Russia has been hit by Western currency sanctions, "China and some other countries should rush to reduce dependence on the dollar."

Seeing how Russia's foreign assets were frozen after its invasion of Ukraine, anti-Western countries are eager to accumulate available gold reserves.

Those familiar with China's gold buying patterns know all too well that Beijing has made similar moves in the past. After keeping radio silent since 2009, Beijing surprised the market in 2015 when it revealed that it had increased gold holdings by some 600 tonnes. It has not reported any activity since September 2019.

"China has likely bought a substantial amount of gold from Russia," some market analysts added. According to them, the People's Bank of China probably bought a portion of the Russian Federation Central Bank's gold holdings of more than 2,000 tons.

It's a rapid accumulation advance to today when, although we still don't know for sure if Russia sold some of its gold to China, all we presuppose is that Russia sold some gold in recent months after its holdings hit a record high in 2021.

 

 

We know this because overnight, the PBOC officially reported an increase in its gold reserves for the first time in more than three years, confirming that the world's most populous country was indeed the mystery buyer in the bullion market.

In keeping with a traditional practice of masking its purchases for years (the "dormant" period between 2009 and 2015 when China disclosed no purchases, then suddenly reported a 57% increase in reserves being the most famous) and then only gradually reporting how much it had bought. The Chinese central bank increased its holdings by 32 tonnes in November from the previous month and actually since the last official update in September 2019, according to data on its website.

 

 

That brought its total to 1,980 tonnes (or 63.67 million fine troy ounces), the world's sixth-largest central bank bullion hoard, but as with previous disclosures, China has likely bought a lot more over the past three years, but will only reveal how much in the coming months. That said, China has a long way to go for its gold holdings to catch up with the U.S. (which may or may not have the gold it represents), and even if combined with Russia's holdings, the two countries would still not be the world's largest gold holder.

 

 

Why now? Well, as Bloomberg reports, "for China, the need to find an alternative to dollars, which dominate its reserves, has rarely been greater." Tensions with the U.S. have been high since the crackdown on its semiconductor companies, while the Russian invasion of Ukraine has demonstrated Washington's willingness to sanction central bank reserves. In other words, now that the US has shown it is ready to weaponize the dollar, any USD reserves held by the Fed, Western banks or any other counterparties could and will be immediately confiscated if China does something nasty...like invade Taiwan. That's why China is desperately seeking money with no counterparty risk. Here it has only two choices: crypto or gold. For now, it has chosen the latter.

China has gone long periods without disclosing changes in its gold holdings. When the central bank announced a 57% increase in reserves to 53.3 million ounces in mid-2015, it was the first update in six years. It took another breather from late October 2016, before resuming purchases in December 2018.

While central bank purchases rarely drive sustainable gold rallies, they can provide an important pillar of support when prices fall. The precious metal has been under pressure this year from the Federal Reserve's aggressive monetary tightening, although it has held up relatively well against movements in the dollar and Treasury yields.

Gold's role may be changing as first Russia, then other countries (China) look to force out the petrodollar and replace it with petro-gold, a move that would ultimately lead to substantial price increases in the yellow metal that has gone nowhere in the last 2 years.

Will an appreciation of Gold come this year 2023?

Gold is usually a good hedge against inflation. But, if there was record inflation last year, why didn't gold perform positively that year 2022? Basically because it has a direct competitor: the nominal interest rate. As bond yields rise, investors have a greater incentive to invest there.

However, the real explanation for gold's movement comes from the real interest rate. Unlike the nominal rate, the real rate takes inflation into account.

Let's look at the evolution of gold (left axis) and the real interest rate (right axis):

 

 

The real interest rate is the nominal rate adjusted for inflation (black line). If this rate rises, gold usually falls and vice versa. In the last few weeks the real rate started to fall (as the nominal rate fell and inflation expectations remained unchanged), so gold reacted upwards.

Why do they have an inverse relationship? Any investor has a greater incentive to buy Treasuries if they have a positive, inflation-adjusted yield. Gold, on the other hand, does not earn any interest, so it loses its attractiveness.

The market continues to discount that inflation will not last long. In fact, 10-year inflation expectations are around 2.3%. What happens if inflation does not come down as the market expects? That would drive down the real interest rate, which would be a big boost for gold.

Another determining factor for gold to rise is the level of debt. For example, in the U.S., total debt is 120% of GDP, a higher ratio than during the Great Depression and post World War II. Below is the current debt-to-GDP ratio at 120%:

 

 

And right away, we show that at the end of World War II (1945) the public debt reached 112% of GDP (red arrow):

 

 

With a government unwilling to raise taxes or cut spending, monetization (issuing money) of the deficit by Central Banks will again be seen as the path of least resistance. What would happen in the face of such monetization? Inflation would remain high, so gold would benefit.

That said, we think at AXL Capital Management that the future for the yellow metal could be auspicious for 2023.

Powell hits back at inflation: "The data is good, but it's not enough."

Federal Reserve Chairman Jerome Powell indicated that the new rate hike will be 25 basis points. He added that the institution is "strongly committed" to reducing inflation and added that "without price stability, the economy does not work for anyone".

Despite this, Powell welcomes the recent inflation data, but says that it is still too early and that the Fed "needs more data to make sure that the rise in prices is slowing in a sustained way." The chairman added that "reducing inflation will likely lead to a below-average growth rate and a cooling of the labor market." However, he also indicated that the labor market remains strong.

 

Powell: "We are talking about a couple more rate hikes".

The president acknowledged that "certainly rates could be higher". Although he wanted to avoid explaining exactly how and when these hikes will be, he acknowledged that they are coming to an end, claiming that "we are talking about a couple more interest rate hikes".

In spite of this, the president has taken his most 'Hawkish' tone, assuring that he prefers to be wrong with rates that are too high than to realize that "we were wrong for not raising rates enough". He also stressed that rates will remain high throughout the year and will not be lowered. "If the economy evolves according to our forecasts, it will not be appropriate to lower rates this year."