Gold's Triple Questions: Who is buying, why buy, will the "derailment" continue?

The price of gold has continuously hit historic highs. As of the time of writing, spot gold has risen in the short term, once again reaching a historic high of $2356.06 per ounce. Wall Street investment banks unanimously pointed out in their reports that the trend of gold prices cannot be analyzed according to previous pricing models. So, who is the "mysterious force" driving the significant rise in gold prices this time?

On April 8th, UBS analysts Joni Teves and Elena Amoruso released a report stating that it is currently difficult to determine a single major source of gold buying. The buying is relatively dispersed, with bullish positions in the gold market significantly increasing. However, there is still some distance from the historical highs. Global physical gold ETFs continue to show outflows. On the other hand, central banks have been actively buying gold during the price increase process. But for most central banks, the proportion of gold in total reserves remains low, leaving room for further increase in central bank gold buying demand.

UBS analysts believe that investors' motivation for buying gold currently includes the following three points:

1. The Federal Reserve's monetary policy and inflation risks. As long as the Fed maintains a dovish stance, the risk of rising inflation means that real interest rates may further decline. Market concerns about long-term high inflation intensify, making gold more attractive as a traditional hedge against inflation.

2. Geopolitical tensions have become a reason for investors to buy gold to hedge risks.

3. The potential impact of the U.S. presidential election on fiscal policy. As the election approaches, concerns about the U.S. fiscal situation may arise, prompting investors to increase their gold holdings.

UBS stated that the recent trend in gold prices completely "deviates" from the trend in real interest rates. Pricing models (considering key factors such as the USD exchange rate, real interest rates, MOVE, and VIX volatility indicators) can no longer explain the rise in gold prices.

However, UBS believes that in the long term, the correlation between gold and real interest rates, as well as the USD, still holds. U.S. real interest rates still represent the opportunity cost of holding gold, and the USD is the main currency for pricing gold. Therefore, the "deviation" of gold from macro fundamentals will not exist forever.

Who is buying gold?

UBS pointed out in the report that it is currently difficult to determine a single major source of buying. Since February, commodity trading advisors (CTAs) have significantly increased their buying, with open interest in gold futures contracts increasing by 24%, but still only around 63% of the historical peak:

Whether we look at total speculative net positions or fund managers' net positions, these positions are only around 57% and 50% of historical highs, respectively. Meanwhile, gold ETFs continue to decline, showing a trend of net outflows. The private wealth management sector has not actively recommended strategies to allocate gold, and a considerable number of investors have almost no exposure to gold UBS pointed out that the above information has several important implications. First, the data shows that the buying interest in gold is more dispersed rather than concentrated in a specific market segment or a few participants. Many investors who have been bullish on gold since the fourth quarter of last year have not actually built positions, as many are waiting for a price pullback.

Second, there may be market participants acquiring gold in ways that are not easily traceable through public data, such as over-the-counter trading or physical trading. Third, a broad and diversified investor base means a more resilient market, which in turn is favorable for maintaining gold prices at higher levels.

UBS emphasized that central bank demand for gold is also significant. The specific purchase scale will be revealed in a few months, but global central banks have shown strong demand for gold over the past 13 years, with gold purchases in the past two years accounting for 27%:

The purchase volume in 2022 and 2023 is about 30% of mine supply, higher than the average level of about 15% in the previous 10 years. Nevertheless, we believe that this trend still has room to continue upward. For many central banks, the proportion of gold in total reserves is still relatively low.

Wall Street News previously mentioned that in a previous report, UBS pointed out that existing statistical data shows that the net purchase volume of central banks in January-February was about 65 tons:

Among them, data released by the State Administration of Foreign Exchange of China shows that in March, China purchased about 5 tons of gold, bringing the total purchase volume for the first quarter to 27 tons. China has been increasing its gold reserves for 17 consecutive months and is currently the largest buyer among central banks, followed by Turkey and India.

Reasons for Buying Now

UBS pointed out several reasons why investors are increasing their gold positions. First, some investors expect that as the Federal Reserve begins an interest rate cutting cycle, real interest rates in the United States will decrease. If the Federal Reserve maintains a dovish stance, the risk of rising inflation suggests that real interest rates may further decline, which would be more favorable for gold. Rising oil prices and commodity prices driven by supply factors may exacerbate these concerns.

Second, global geopolitical tensions have increased reasons for investors to hold gold. Due to the many variables in geopolitics, it seems reasonable in this environment to use gold as a hedge against any potential escalation of geopolitical risks.

Finally, in the numerous elections held this year, the U.S. presidential election in November may be increasingly on the radar of gold market participants. **As investors consider the potential impact on fiscal policy, concerns about the rising U.S. debt and budget deficit may come to the forefront UBS believes that while any of these factors may not seem sufficient on their own, when considered together, they provide quite compelling reasons for investors to increase their holdings of gold.

Will the "decoupling" between real interest rates and the US dollar persist in the long term?

UBS previously pointed out that, as shown in the chart below, model results indicate that the recent trend in gold prices has completely "diverged" from the trend in real interest rates. Since the beginning of this year, when real interest rates have been declining, the beta coefficient between gold prices and 10-year US Treasury Inflation-Protected Securities (TIPS, real interest rates) has been negative. However, when real interest rates rise, this coefficient turns positive, contradicting the traditional understanding (i.e., rising real interest rates lead to a decline in gold prices).

UBS states that residual analysis shows that the model cannot explain most of the recent increase in gold prices. In addition to the traditional influencing factors such as the US dollar exchange rate, real interest rates, and uncertainty indicators, there may be other important drivers that have pushed up gold prices recently.

UBS points out that the relationship between gold and macro variables is not permanently broken. Upon re-examining the gold pricing model, it can be seen that in recent years, the sensitivity of gold to real yields has decreased relative to historical levels. When real interest rates are higher (such as the present and the early 2000s), gold tends to be less sensitive to them.

UBS believes that these relationships still hold true in the long term, with US real interest rates representing the opportunity cost of holding gold, and the US dollar being the primary currency for gold pricing, thus creating an inherent negative correlation