Why gold’s pullback does not change the long term outlook

The tensions in the Middle East have pushed energy prices higher. These higher energy prices have increased inflation expectations, as energy costs feed through into transportation, production and household expenses. As a result, markets have become more cautious and have reassessed the outlook for interest rates.

When inflation expectations rise, investors tend to expect higher interest rates. Higher interest rates tend to strengthen the US dollar, and both a stronger dollar and higher rates make gold less attractive in the short term. Unlike interest-bearing investments, such as bonds or savings products, gold does not pay income, which makes it less attractive to investors when returns on those investments increase.

While inflation dynamics and a stronger US dollar also weighed on gold, the dominant driver of the recent price correction was investor behaviour. After the strong rally earlier this year, many investors chose to take profits, increase their liquidity and reduce risk. This selling pressure caused notable price movements, even during periods of geopolitical tension.

These sharp price swings have also discouraged traditional dip buyers. Long term institutional investors and central banks, who typically add to positions when prices weaken, have been reluctant to step in amid elevated volatility. As a result, price declines have not been met with the usual stabilising demand.

Investor behaviour differs across regions. In Western markets, investors continue to withdraw money from gold ETFs. China is an exception. There, gold ETFs have seen net inflows, and demand for physical gold is strong, especially for gold bars. This demand appears to be driven less by the search for quick profits and more by long-term investment and wealth diversification.

Tensions in the Middle East remain the key risk factor for gold and mainly affect it through oil prices. If the conflict eases, oil prices fall and inflationary pressure could decrease. But if the conflict drags on, oil prices could stay high. That would increase concerns about inflation and could eventually also slow economic growth. In the short term, gold prices are therefore likely to respond most strongly to inflation and interest rate expectations. In the longer term, attention may shift to the risk of a stagflation scenario, which is a situation with low growth and high inflation. In such an environment gold may act as an inflation hedge.

On the supply side, conditions remain favourable for gold. Mine production is growing slowly and does not respond quickly to higher prices. The supply of recycled gold has increased only slightly after the price rise in January. While global trade in gold has also become more geographically spread out, particularly with the growing importance of Asian markets, this mainly affects logistics rather than supply. This sometimes causes short-term disruptions, but it does not significantly change the overall supply of gold.

Furthermore, longer term demand remains supportive. Persistent geopolitical risks, the risk of economic shocks and rising demand for diversification are encouraging investors to maintain higher allocations to gold. A broader investor base could help sustain the current upward cycle and allow gold prices to settle at higher levels over time, even in a high interest rate environment.

We believe that gold is in the later phase of an upward market cycle. By the end of the year, we expect prices to move to a higher price level than today. A sharp decline in the gold price seems unlikely, while the likelihood of further increases remains greater, especially if geopolitical tensions persist. For investors, gold continues to serve as an important portfolio diversifier, rather than as a vehicle for short-term investment returns. The long term case for gold remains supportive, and we have therefore recently increased our allocation to gold.

Jan Wirken
Equity Research & Advisory Expert