Gold Market Commentary

Key highlights

• Gold jumped 6% m-o-m in February, to US$1,910/oz ¹, the largest monthly gain since May 2021
• Safe-haven demand outweighed higher nominal yields and a marginally stronger dollar, as Russia’s invasion of Ukraine ramped up volatility and uncertainty
• COMEX net positioning in gold rose to its highest level since July 2020 and gold ETFs added another US$2bn (35t) to global AUM

Looking forward

• The risk of economic slowdown amid high inflation could complicate monetary policy decisions, further supporting investment demand for gold

Gold responds to geopolitical tensions

The LBMA Gold Price PM jumped 6% in February, ending the month at US$1,910/oz. It’s the strongest m-o-m performance since May 2021, as weeks of rising tensions culminated in Russia’s invasion of Ukraine and geopolitics taking centre stage.

Inflation and interest rates remained important drivers for gold; hot CPI prints in the US and Europe earlier in the month confirmed that inflation shows little sign of abating. But, amid rising volatility and with geopolitical tensions in Ukraine dominating headlines, safe-haven demand for gold outweighed the impact of higher nominal yields and a marginally higher US dollar.

This is corroborated by our gold return attribution model (GRAM), which shows that while rising yields created headwinds for gold during the month, they were more than offset by other factors including higher US 10-year breakeven rates and momentum from gold ETF flows (Chart 1). Given that our model is based on long-term historical data, the unexplained component likely captured geopolitical concerns that weren’t fully reflected in other variables such as the US dollar, volatility or oil, which normally react strongly in times of geopolitical instability.

General risk-off sentiment was evident throughout the entire month (Chart 2). Global equity markets were significantly down in February, extending the y-t-d decline. Nominal yields fell during the second half of February, coinciding with rising geopolitical tensions, although still ended higher on the month. Fears over the inflationary impact of the Russian invasion also led to the spread between 2- and 10-year US Treasury yields narrowing to its lowest level since April 2020. What’s more, findings from the latest Bank of America fund manager survey show that cash allocations rose to their highest levels since May 2020.

COMEX net positioning and inflows into gold ETFs were also supported by this risk-off sentiment. Net positioning in gold futures jumped to US$56bn (904t) in the week ending 1 March, the highest level since July 2020 (Chart 3). Gold ETFs continued to see inflows throughout the month, with AUM rising US$2bn (35t). These inflows were almost evenly split between US- and European-listed funds.

Looking ahead: interest rates likely to rise, but by how much?

March brings the long-awaited Fed meeting where interest rates are expected to be lifted for the first time since 2018. While a full 25bp hike is still priced in, expectations have fallen significantly from earlier in the month when the market was pricing almost a 50bp increase. The European Central Bank and Bank of England are also due to meet, with the former not expected to raise rates until later in the year at the earliest, while the latter is expected to raise rates again. But the conflict in Ukraine heaps further uncertainty onto an already foggy outlook.

Central banks, already grappling with multi-decade high inflation, must now assess how this conflict may further destabilise markets. An important consequence of the Ukrainian conflict may be to propel inflation even higher, given Russia’s position as a key energy supplier. Oil prices leapt 9% during the month, breaking above US$100/bbl for the first time since 2014 and placing additional pressure on the global economic recovery.²

Any potential economic slowdown may limit the extent to which central banks can tighten monetary policy or the policy options available should further support be needed. The risk of a slowdown is particularly acute in Europe, given the importance of Russian energy supplies to the region. There is also the question of whether greater pressure on disposable incomes will help bring down inflation naturally in the medium term. If expectations of interest rate rises were to soften further, and fears of stagflation re-emerge, this may further benefit gold investment demand. While upcoming CPI prints – such as eurozone CPI hitting a record 5.8% in February – will be important in tracking how inflation is progressing, the dilemma for central banks is far from simple.

Such inflationary pressure may limit the ability of bonds to serve as a safe-haven asset in portfolios, given the impact to fixed income streams. This may further boost interest in gold as a diversifier, with its historical strong performance during periods of high inflation and its deep and liquid market. And recent events represent a clear example of why gold is such an effective and well-established hedge against both expected and unexpected market risks.

Regional insights

China: Following strong retail gold consumption during the Chinese New Year Holiday (CNY) in early February, a decline in Au9999 trading volumes indicated that wholesale physical gold demand weakened during the month.³  This is likely due to manufacturers' replenishing their stocks before CNY and fewer working days compared to January. Correspondingly, the local gold price premium fell during the month.

Meanwhile, local gold ETF holdings declined in February. It seems that many Chinese investors continue to act tactically in their gold ETF allocations: the rising gold price might have spurred profit-taking, contributing to the monthly outflow.

India: Following soft demand in January, retail demand further weakened in February. The sudden spike in the gold price following the invasion of Ukraine caught consumers off guard, resulting in the postponement of gold purchases during the second half of the month. This weakness in retail demand caused the local price discount to widen to US$14-15/oz by the end of February, compared to a small premium of US$1-2/oz in the first half of the month.

Indian gold ETFs witnessed fractional outflows of 0.5t in February, primarily driven by the higher gold price, which may have led to profit-taking. Indian gold ETF total holdings decreased to 36.2t by month-end.

Central banks: At the end of February the Central Bank of Russia (CBR) announced that it would be resuming its gold buying from the domestic market following tougher international sanctions. It has been two years since Russia suspended its gold buying, having accumulated over 1,900t between 2006 and 2020 (Chart 4). Russia’s gold reserves stood at just under 2,300t at the end of January, accounting for 21% of total reserves.

You can read more about central bank demand in January on the Goldhub blog.

ETFs: Gold ETFs added a further 35t (US$2bn) to global AUM in February (Table 1).⁴  Total holdings in these products now stands at 3,651t (US$224bn), the highest level since February 2021.⁵   Inflows were again concentrated in North American and European funds, although more evenly split compared with January. Modest outflows were again seen in Asia, led by Chinese ETFs.