What Message is Gold Sending?
By Adam Thurgood on February 13, 2025
What Message is Gold Sending?
At roughly six weeks into the new year, gold is the asset class shining most brightly. After a stellar 2024 (up 27%!), the shiny metal has continued its run by surging another 10% so far this year, outpacing stocks by a wide margin. We have a sizable position in gold across most of our portfolios. As a result, we are constantly assessing the gold market trying to determine what is driving the price and where we are likely to go next.
As a starting point, it is important to remember that gold is a scarcity asset, while stocks tend to be productive assets. Gold tends to do well when scarcity is in favor, which often occurs for two reasons. First, when fear is present in the system and there is a flight to safety, and second, when money supply is growing quickly (or projected to grow quickly). Real interest rates, the direction of the dollar, and other factors impact the price of gold, but at its core, the scarcity component is most important.
For many years, the price of gold and the demand for scarcity was a western story. When the gold ETF (GLD) was launched in 2004, constant demand from western investors pushed gold up year after year. As you can see in the chart below, the growth in the gold price was one in the same with the growth in GLD shares outstanding, that is until 2022. Since then, western investors have been redeeming shares of GLD while the price of gold ripped higher. So, who are the buyers?
As we discussed in a bullish video on gold early last year, we believe one of the worst tactical moves in economic history may turn out to be how the West handled Russian central bank reserves after the invasion of Ukraine. The U.S., along with the U.K., Japan, and Germany, essentially seized hundreds of billions of dollars of Russian central bank reserves held in the form of treasuries of western governments. This move sent shock waves through the banking world, causing any astute central banker to at least consider allocating some portion of their reserve assets to gold instead of treasuries. And that they did!
Each year, roughly 3,000-3,500 metric tons of gold are produced (purple in the chart below), and central banks have been buying about 1/3 of it. With jewelry demand at roughly 2,000 tons annually, nearly all of the newly mined gold is spoken for. That is a bullish setup as long as central banks keep buying at their current pace. One could argue that the gold demand from central banks is due to the fear of reserve asset seizure and this demand will be long lasting.
During precious metals bull markets that are less driven by fear, gold tends to move first, and silver follows with even more ferociousness. It is the relative move higher in silver that provides an all-clear signal, which makes sense, as silver is both a precious metal and an industrial metal. A rising silver price rarely occurs in a horrible economic environment. To-date, we have not seen that move. The gold to silver ratio is concerningly elevated.
The higher the ratio, the less silver is participating in the move. With today’s ratio at 91, we are much higher than the long-term average of 62, higher than the post financial crisis average of 72, and even higher than the post Russian invasion average of 85. This is a bit concerning, as it could be auguring something more pernicious is on the horizon.
Another indicator we are keeping our eyes on is the S&P 500 to gold ratio. As you can see in the chart below, this ratio tends to trend for long periods of time. When the ratio (orange line) is above the seven-year moving average (blue line), the coast is usually clear for stocks. However, once a clear break below the line occurs, stocks materially underperform gold. Today, we sit just below the line, raising concerns that the move higher in gold is foretelling something more ominous about the economy. However, with stocks near record highs, it is hard to argue that fear is the driving force. Instead, perhaps the money supply factor is at play, which is bullish for both stocks and gold.
While money supply is back in positive growth territory after contracting through most of 2023, the growth rate is still below the pre-covid average. If the money supply factor is a driving force, it is likely where market participants believe money supply is headed rather than where it currently sits. With government spending still out of control globally, it seems likely that money supply growth is a legitimate concern and is driving gold higher.
Putting it all together, we have a solid and likely sustainable fear bid in gold coming from central banks. Even if the Russian/Ukraine situation is resolved and Russian central bank reserves are returned, the cat is out of the bag, and we will likely continue to see gold play a larger role on central bank balance sheets. With the gold to silver ratio elevated, there may also be a fear bid from traders around the globe about what might be on the horizon. Additionally, with the S&P 500 to gold ratio breaking down with stocks near an all-time high, money supply growth concerns are likely playing a role.
This essentially means that gold is firing on all cylinders, which makes the parabolic move higher over the last year understandable. The question becomes whether it is sustainable. We saw a similar surge higher in the price of gold back in 2018 through early 2020, after which it traded sideways for nearly three years. That situation could certainly play out again if some of the fear or money supply drivers ease. However, outside of risk managing the position size and trimming a bit of exposure to lock in some gains, the fundamentals for a secular gold bull market remain in place. As such, we believe maintaining a healthy exposure to gold is wise.
