Show Transcript
The price of gold has surged almost 30% this year as the precious metal hits record highs. Bart Melek, Managing Director and Global Head of Commodity Strategy at TD Securities, speaks with MoneyTalk’s Greg Bonnell about where demand is coming from and why the upward trend is likely to continue.
Print Transcript
Price of gold has run up to record levels in recent trading. But as the Fed begins its rate-cutting cycle, will the rally continue? Joining us now to discuss, Bart Melek, Managing Director and Global Head of Commodity Strategy at TD Securities. Bart, great to have you back on the show.
It's wonderful to be back. Thank you.
All right. We're going to talk about where you think gold could possibly be headed. But let's talk about what got us here in the first place-- a lot of moving parts.
Yes, absolutely. I think we should probably start back some 12 months ago, where we had the Federal Reserve-- at that time, no one was really imagining a 50 basis points cut like we saw last Wednesday. But what we did witness is very robust central bank buying, and that's on the back of a record level of central bank purchases in 2022/2023.
This year started off fairly robustly as well. It has slowed down. But that was one of the elements, along with strong physical markets in Asia and other parts of the world, that prevented gold from troughing in a material way, even as rates were on the way up, or certainly real rates anyway, as inflation fell and we saw the Fed funds at 550 basis points.
So there was already a robust market. And the economy started slowing a little bit. China underperformed. And the narrative shifted towards cuts. And of course on Wednesday, the Federal Reserve delivered a 50 basis points cut and a dovish narrative.
But ahead of that, the markets were expecting it for the most part. And we've seen very, very robust proprietary trader or discretionary trader positions. We at some point thought it was maybe a little bit too much too soon. And that helped to move gold to the record levels we've seen-- robust, speculative purchases and the start of ETF buying.
We haven't really seen the market go firing on all cylinders. And in our view, we still think there's some upside to go as we move into early 2025.
So we've seen that strong demand from central banks. You're seeing ETF holdings starting to rise and a 50 basis point cut from the Fed. I imagine the gold bulls like all of these components. Is it more complicated than that?
Yes. [LAUGHTER]
It's always more complicated. If life was simple, we would all be minted.
Well, central banks since then have slowed down a bit. I think the People's Bank, after almost two years of very aggressive buying, slowed down for the last five months or so. But we suspect that central banks may be interested again. I think the hope on their part was that we could see a bit of moderation because, as I said, it looked like there was maybe too much positioning on the long end.
But now, I think central banks may be in it again. And I think the generalists and institutional investors in the Western world may develop an appetite for gold again. And with a 50 basis points cut, even though we had very hefty positions, we really didn't see, last week in the CFTC data, that would indicate a lack of appetite.
In fact, long positions grew much more than short positions. So length increases were still pretty hefty in terms of positioning, which represents a risk. But I suspect this particular Fed is very much tilted towards the second element of its mandate, which is maximum employment.
The Federal Reserve, unlike, let's say, the Bank of Canada, targets two policies or two things they want to accomplish simultaneously. They want to have price stability, which is controlling inflation, and they want max employment-- maximum employment.
And I think Mr. Powell, starting back in August at Jackson Hole, I think with very little ambiguity told the market that he doesn't want the labor market to weaken much more. The rest of the economy, in many ways, has slowed down. There are disinflationary pressures-- not deflation, but inflation has decelerated a great deal.
And the Fed now is quite comfortable, I think, with the idea that we are going to move to their 2% target. And that, of course, takes time. But at the same time, the Fed wants to reduce the restrictive aspect of monetary policy to facilitate a little bit more economic activity so we don't see a very sharp downturn in labor.
So they're trying to hit two things at the same time. Historically, that didn't end well, because through much of the history, it ended up in a significant slowdown and even recession. This time we're hoping that we're going to have more of a soft landing as this Federal Reserve starts cutting rates. And we're hoping that things stimulate and we get the best of both worlds-- low inflation and decent growth.
There's a lot of consensus around this idea that they can stick the soft landing. What if they don't? What if it ends up being a hard landing, you get a recession, and a rather painful one-- what would happen to gold?
Well, gold seems to be a winner under most scenarios here. If there is a very sharp downturn, one we don't expect, then the Federal Reserve's response would be more monetary easing, even lower real interest rates. There are some rigidities on the price side. It's unlikely that we're going to get deflation, de facto.
So you could very much envision a world where the economy slows down much more than the Fed anticipated. And I think the reaction function would be to aggressively cut rates. And for gold, that's pretty good.
One, you're protecting against the deterioration in real rates as the Fed cuts. And also, gold tends to have an inverse relationship to risk assets, like equities, for example, or copper, or other things. So when the economy's slow, demand for industrial metals or energy doesn't tend to do well. Earnings tend to disappoint, and then gold tends to be an outperformer as rates go down and gold is seen as being relatively stable.
Lastly I want to ask you, let's talk about that-- we talk about gold in the here and now and the things that have happened-- very interesting moves, as you've laid out on the show over the past couple of years. Historically, though, what place has gold played? It's an interesting asset in that respect.
It is. First of all, gold is no one's liability. There is no counterparty risk. If I own an ounce of gold, I own an ounce of gold. I don't have to rely on any government to pay me your yield or pay me back. There is intrinsic value in it. So far, so good. For the last 5,000 years or so, gold has been considered valuable by humanity, a store of value.
We're assuming for the next 10 years or so, it'll be the same thing. So it's a store of value. It doesn't have to depend on the good graces or solvency of any government.
Second, it is a real asset that requires real resources to produce and to take out of the ground. That includes labor. That includes capital in the form of those big mighty machines that dig stuff out, everything from water pumps, to trucks, to smelters. And if we argue there is inflation in the world, well, then, we have to argue that the cost of labor is going to catch up and so will the cost of everything associated with getting an ounce out of the ground in terms of capital, and steel girders, and you name it.
And other third factor I think that is very important here is that the average or grade is declining over time. We've been mining it for many, many thousands of years, and all the good stuff that's easy to get at has been pretty much mined out. If it was easy to get out of the ground, people knew about it and tried to take it out.
Now, we're left with more troublesome assets, new assets, in particular. Some were high up in the Andes Mountains or in geopolitically unstable parts of Africa, for example. And to the extent that price of gold has tracked the marginal cost, or we call it the 90th percentile of the cost curve, then as we move forward and if we expect inflation down the road, it's a good protector. It gives you a real implied yield of sort.
So if labor goes up by 2% or 3% and you're going to need more labor to get that ounce because there is less of gold available, more machinery, given technology doesn't change much, then gold should deliver inflation plus that extra premium that is reflected in the difficulty of getting an ounce out of the ground.
So I think over the long run, it should be a decent reflector of aggregate prices in the world and should keep up. So in 50 years time you should probably still have, in real terms, the same amount of purchasing power from $100,000 worth of gold today-- in 50 years, probably you will get $50,000 in real terms of purchasing power as well.
So it's not a bad asset. And unlike equities, for example, you can imagine in 50 years, technology stocks that are all the rage today may not be, because they'll be outmoded and outdated. There's no guarantee that today's technology will be around in 50 years or will there be the same companies. So there's that element as well, which is stable, a store of value that's been around for many millennia.
[MUSIC PLAYING]
Price of gold has run up to record levels in recent trading. But as the Fed begins its rate-cutting cycle, will the rally continue? Joining us now to discuss, Bart Melek, Managing Director and Global Head of Commodity Strategy at TD Securities. Bart, great to have you back on the show.
It's wonderful to be back. Thank you.
All right. We're going to talk about where you think gold could possibly be headed. But let's talk about what got us here in the first place-- a lot of moving parts.
Yes, absolutely. I think we should probably start back some 12 months ago, where we had the Federal Reserve-- at that time, no one was really imagining a 50 basis points cut like we saw last Wednesday. But what we did witness is very robust central bank buying, and that's on the back of a record level of central bank purchases in 2022/2023.
This year started off fairly robustly as well. It has slowed down. But that was one of the elements, along with strong physical markets in Asia and other parts of the world, that prevented gold from troughing in a material way, even as rates were on the way up, or certainly real rates anyway, as inflation fell and we saw the Fed funds at 550 basis points.
So there was already a robust market. And the economy started slowing a little bit. China underperformed. And the narrative shifted towards cuts. And of course on Wednesday, the Federal Reserve delivered a 50 basis points cut and a dovish narrative.
But ahead of that, the markets were expecting it for the most part. And we've seen very, very robust proprietary trader or discretionary trader positions. We at some point thought it was maybe a little bit too much too soon. And that helped to move gold to the record levels we've seen-- robust, speculative purchases and the start of ETF buying.
We haven't really seen the market go firing on all cylinders. And in our view, we still think there's some upside to go as we move into early 2025.
So we've seen that strong demand from central banks. You're seeing ETF holdings starting to rise and a 50 basis point cut from the Fed. I imagine the gold bulls like all of these components. Is it more complicated than that?
Yes. [LAUGHTER]
It's always more complicated. If life was simple, we would all be minted.
Well, central banks since then have slowed down a bit. I think the People's Bank, after almost two years of very aggressive buying, slowed down for the last five months or so. But we suspect that central banks may be interested again. I think the hope on their part was that we could see a bit of moderation because, as I said, it looked like there was maybe too much positioning on the long end.
But now, I think central banks may be in it again. And I think the generalists and institutional investors in the Western world may develop an appetite for gold again. And with a 50 basis points cut, even though we had very hefty positions, we really didn't see, last week in the CFTC data, that would indicate a lack of appetite.
In fact, long positions grew much more than short positions. So length increases were still pretty hefty in terms of positioning, which represents a risk. But I suspect this particular Fed is very much tilted towards the second element of its mandate, which is maximum employment.
The Federal Reserve, unlike, let's say, the Bank of Canada, targets two policies or two things they want to accomplish simultaneously. They want to have price stability, which is controlling inflation, and they want max employment-- maximum employment.
And I think Mr. Powell, starting back in August at Jackson Hole, I think with very little ambiguity told the market that he doesn't want the labor market to weaken much more. The rest of the economy, in many ways, has slowed down. There are disinflationary pressures-- not deflation, but inflation has decelerated a great deal.
And the Fed now is quite comfortable, I think, with the idea that we are going to move to their 2% target. And that, of course, takes time. But at the same time, the Fed wants to reduce the restrictive aspect of monetary policy to facilitate a little bit more economic activity so we don't see a very sharp downturn in labor.
So they're trying to hit two things at the same time. Historically, that didn't end well, because through much of the history, it ended up in a significant slowdown and even recession. This time we're hoping that we're going to have more of a soft landing as this Federal Reserve starts cutting rates. And we're hoping that things stimulate and we get the best of both worlds-- low inflation and decent growth.
There's a lot of consensus around this idea that they can stick the soft landing. What if they don't? What if it ends up being a hard landing, you get a recession, and a rather painful one-- what would happen to gold?
Well, gold seems to be a winner under most scenarios here. If there is a very sharp downturn, one we don't expect, then the Federal Reserve's response would be more monetary easing, even lower real interest rates. There are some rigidities on the price side. It's unlikely that we're going to get deflation, de facto.
So you could very much envision a world where the economy slows down much more than the Fed anticipated. And I think the reaction function would be to aggressively cut rates. And for gold, that's pretty good.
One, you're protecting against the deterioration in real rates as the Fed cuts. And also, gold tends to have an inverse relationship to risk assets, like equities, for example, or copper, or other things. So when the economy's slow, demand for industrial metals or energy doesn't tend to do well. Earnings tend to disappoint, and then gold tends to be an outperformer as rates go down and gold is seen as being relatively stable.
Lastly I want to ask you, let's talk about that-- we talk about gold in the here and now and the things that have happened-- very interesting moves, as you've laid out on the show over the past couple of years. Historically, though, what place has gold played? It's an interesting asset in that respect.
It is. First of all, gold is no one's liability. There is no counterparty risk. If I own an ounce of gold, I own an ounce of gold. I don't have to rely on any government to pay me your yield or pay me back. There is intrinsic value in it. So far, so good. For the last 5,000 years or so, gold has been considered valuable by humanity, a store of value.
We're assuming for the next 10 years or so, it'll be the same thing. So it's a store of value. It doesn't have to depend on the good graces or solvency of any government.
Second, it is a real asset that requires real resources to produce and to take out of the ground. That includes labor. That includes capital in the form of those big mighty machines that dig stuff out, everything from water pumps, to trucks, to smelters. And if we argue there is inflation in the world, well, then, we have to argue that the cost of labor is going to catch up and so will the cost of everything associated with getting an ounce out of the ground in terms of capital, and steel girders, and you name it.
And other third factor I think that is very important here is that the average or grade is declining over time. We've been mining it for many, many thousands of years, and all the good stuff that's easy to get at has been pretty much mined out. If it was easy to get out of the ground, people knew about it and tried to take it out.
Now, we're left with more troublesome assets, new assets, in particular. Some were high up in the Andes Mountains or in geopolitically unstable parts of Africa, for example. And to the extent that price of gold has tracked the marginal cost, or we call it the 90th percentile of the cost curve, then as we move forward and if we expect inflation down the road, it's a good protector. It gives you a real implied yield of sort.
So if labor goes up by 2% or 3% and you're going to need more labor to get that ounce because there is less of gold available, more machinery, given technology doesn't change much, then gold should deliver inflation plus that extra premium that is reflected in the difficulty of getting an ounce out of the ground.
So I think over the long run, it should be a decent reflector of aggregate prices in the world and should keep up. So in 50 years time you should probably still have, in real terms, the same amount of purchasing power from $100,000 worth of gold today-- in 50 years, probably you will get $50,000 in real terms of purchasing power as well.
So it's not a bad asset. And unlike equities, for example, you can imagine in 50 years, technology stocks that are all the rage today may not be, because they'll be outmoded and outdated. There's no guarantee that today's technology will be around in 50 years or will there be the same companies. So there's that element as well, which is stable, a store of value that's been around for many millennia.
[MUSIC PLAYING]
