The gold market

Gold has fascinated mankind for millennia and continues to generate debate. If you study history, you will see that the value and attractiveness of gold has endured for thousands of years. It is a metal that retains its beauty no matter what happens and if there has been a war, it has never been destroyed. Gold also has other properties that make it suitable for industrial use as it has good electrical conductivity, does not oxidize and is more malleable than any other metal. These various components have led people in many different cultures to value gold. People have considered gold to be a stable store of value and something that can be traded for or exchanged for cash.

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Extraction

Gold is a rewarding metal to mine in that it does not rely on smelters in the same way as base metal production. A smelter can take as much as 50% of the metal value in charges. Gold can be produced at the mine by leaching or flotation (chemical methods) or gravimetry (washing machines). It can then be sold to refineries and the fees for refining are less than one percent of the gross value. The refineries then sell the gold in the form of bars or coins. The largest market for gold in the world is the London Bullion Market. It trades in bars containing 400 ounces of gold. One such bar weighs 12.44 kg.

Gold consumption rises but production levels off
flattens out

Total gold consumption is usually divided into three categories: jewelry, investment and industrial use.

The jewelry industry

The jewelry industry demands about 2,000 tons of gold annually and the two dominant markets are China and India[1][2]. The jewelry industry is the largest consumer of gold, consuming almost 50% of total production from mines and recycling. Buying interest tends to increase when prices fall and decrease when prices rise, which is to be expected as the end consumer is an individual about to get married or similar. Gold recovery is high and amounts to about half of the amount consumed by the jewelry industry. Approximately 90% is from melted down jewelry and the rest from the industrial sector.

Investments in ETFs decline

Investments in gold are made either in physical gold in the form of gold bars and coins or as a financial product. In the 2000s, so-called ETFs (Exchange Traded Funds) have been created. These are funds that buy physical gold or gold in the form of financial instruments such as futures and options. ETFs currently hold over 3,000 tons of gold and have been a popular investment in Europe and the US[3]. However, ETFs have been sellers of gold for the past three years. The decline in interest in gold ETFs coincides with a weaker household economy in Europe and the United States and the start of interest rate hikes in early 2022.

Investments in physical gold increase despite interest rate developments

However, demand for physical gold from central banks and individuals has continued to increase despite rising interest rates. One reason usually given is that if real interest rates are negative, gold is a better investment than government bonds or money in the bank. The assumption is that the price of gold will rise in line with inflation over time. Real interest means the interest rate received minus inflation. For example, if the interest rate is four percent and inflation is five percent, the real interest rate will be negative, -1 percent. With this reasoning, high interest rates in themselves are not harmful to the price of gold, but it is only when the real interest rate becomes positive that gold comes under pressure. When Paul Volcker became governor of the US Federal Reserve, he raised interest rates to 20% in 1980, which was well above the US inflation rate of 14.5%. So people were paid a lot to save money in the bank or in bonds. Gold came under pressure, as did inflation, and confidence in the economy returned.

Industrial use

The industrial use of gold comes mainly from the electronics industry. Every mobile phone and computer contains gold. Industrial demand has been around 300 tons per year in recent years but is on the rise as AI developments require more computing power.

Production of gold

Around 3 600 tons of gold are produced in the world every year.[4] China, Russia, Australia, Canada and the United States are the countries that currently mine the most gold.[5]. Gold production peaked in 2018 at 3,655 tonnes and has since stagnated, according to the World Gold Council, compared to the 187,000 tonnes of gold produced throughout history. The figure is an estimate by the US Geological Survey. Central banks own 36 000 tons of that gold according to official figures.

From gold as currency to Fiat money and inflation (fiat money is the opposite of money based on commodities. It has no intrinsic value)

Gold pieces were used in early trade and the first coin was created by King Croesus, who is said to have stamped gold pieces with symbols to increase his own publicity. Much later, goldsmiths started issuing receipts for gold deposited and thus the first banknote was created. In conjunction with this innovation, goldsmiths also started lending out receipts for deposited gold, making goldsmiths the first bankers. Ever since, our money has been partly backed by metals and most often it has been gold.

Sweden has also used gold, silver and copper as money, but the link to gold was removed in 1931 during the Depression. Many other countries followed suit and abolished the gold standard. In the United States, President Roosevelt decided to ban the holding of gold in 1933. This decision came after the banking system suffered a crisis of confidence. People had exchanged their dollars for gold at the then prevailing exchange rate of $20.67 per ounce of gold. They were now forced to hand over their gold to the government at that exchange rate. The following year, Roosevelt had the dollar devalued so that an ounce of gold was now worth $35 instead of $20.67. This measure allowed him to increase the money supply in order to boost the economy.

At the end of the Second World War, representatives of 44 countries met in the small town of Bretton Woods on the east coast of the United States. They decided to introduce a new monetary system that has come to be known as Bretton Woods. This meant that central banks could exchange dollars for gold at the Federal Reserve at a fixed exchange rate of $35 per ounce.

Thus, until 1971 within the Bretton Woods system, currencies had a fixed exchange rate against the US dollar[6]. One ounce of gold (31.1 grams) was equal to 35 dollars. Central banks were entitled to exchange their dollar assets for gold with the US Federal Reserve. The Bretton Woods system fell when it became clear that the United States could no longer fulfill its promise to exchange dollars for gold. So much money had been printed to finance the Vietnam War that there was no way to redeem these 'receipts' for deposited gold. As a result, the price of gold rose from $35 in 1971 to a peak of $850 in 1980. The rise in the price of gold in the 1970s was largely the result of a doubling of the money supply and very high inflation. Interest rates were raised to 20% at the end of 1980, bringing the money supply and inflation under control. Since the early 1980s, interest rates in the Western world have been on a downward trend, with central bank rates falling to 0 or even below 0. As we know, this trend was broken during the pandemic.

Central banks in Europe decide to sell gold at the bottom of the price decline

Central banks have held gold as a reserve ever since they were established. The original mandate to issue money was based on central banks holding gold. At the end of the gold price decline in the 1980s and 1990s, a number of central banks made the analysis that their gold was only going down in value and that they could get a better return if they invested their assets in fixed income bonds. They extrapolated the trend they had experienced between 1980 and 1999 into the future. They ignored the fact that gold holdings were a cornerstone of their business. One by one, central banks in Europe lined up to sell. The Bank of England was early to sell half its gold reserves at an average of USD 275 per ounce. Under the Washington Agreement, it was decided that the euro countries, Switzerland, Sweden and the UK would coordinate their gold sales[7]. Sweden's Riksbank joined the agreement and sold a third of its holdings. Many of the most respected economic experts of the time took a decision that would prove to be completely wrong. Sentiment about gold was extremely negative and thousands of articles were published on the theme that gold had played out its role. The joint decision of the central banks is an example of the groupthink that often takes hold of humanity and can conquer even our top economic experts.

So who is buying gold these days? The European central banks are definitely not buyers of gold after their blunder of selling at the bottom. However, there is one outlier and that is Poland, which does not have the euro as its currency. Poland was the second largest buyer of gold in the world in 2023. Poland has expressed that it wants to increase its gold reserves to 20% of its foreign exchange reserves from just over 12.7% today, so it will continue to be a major buyer of gold.

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Embargo and freeze
of Russian assets sharply increase central bank purchases

There has been a noticeable increase in central bank purchases since the decision was taken in the West to freeze Russian bond assets held in US dollars within the European Euroclear system. This is the same system in which your listed shares are registered and Euroclear ensures that dividends on shares and interest on bonds are paid into your accounts. These payments have been stopped in the case of Russia's assets and have instead been paid to Ukraine. This has alarmed countries that do not have good relations with the US and Europe and since the decision was taken, their purchases of gold have increased sharply. In the decade before the invasion of Ukraine, central bank purchases averaged 512 tons per year. In 2022, the year of the invasion, purchases increased to 1 082 tons. Purchases in 2023 and the first half of 2024 are at the same high level[8].

China boosts purchases and may be on track to create world's largest gold reserve

China, which previously only reported its gold holdings every five years, now reports monthly on how much gold it buys and it also reports on how much US Treasuries it sells. It all looks like a protest against the West's actions. The Chinese public follows the government's actions and also buys gold, as do many non-Western countries. China has a gold reserve of 2,262 tons, which represents 4.6% of official reserves[9]. However, there are factors that lead the market to speculate that China has the largest gold reserve of all, perhaps twice that of the US. The first factor is that China has been the world's largest gold producer since 2007 and that there is an export ban on the gold coming from its mines. China's mine production since 2000 has totaled 6,830 tons of gold[10]. China is also a major importer of gold and there are statistics on how much gold China buys from Hong Kong.

The country imports from elsewhere too, but statistics are not available. Since 2000, China has imported 6 700 tons of gold from Hong Kong. In the mining world, it is known that China is also a major importer of unrefined gold, which it buys directly from mining companies. There are no statistics on these imports at all. If we assume that all domestically produced gold ends up with the Chinese government, as well as the imported gold from Hong Kong, China has an unofficial gold reserve of almost 16,000 tons, compared to the United States' 8,133 tons.

Should we count on a
BRICS currency?

There is now talk of creating a BRICS currency to use in place of the US dollar. There is speculation that this currency would be partially backed by gold, which would help explain the Chinese purchases of gold. The BRICS grouping consists of Brazil, Russia, India, China and South Africa. When the term was coined, these were the countries referred to. This year, Egypt, Ethiopia, Iran and the United Arab Emirates have also joined. There is also talk of NATO member Turkey and Saudi Arabia joining, which is seen as very controversial if it actually happens. Until recently, world trade has been conducted in US dollars, but the BRICS countries are making efforts to move away from the dollar. The Chinese currency is currently used in about 4.5% of world trade, while the US dollar is used in about 90% of world trade. The dollar's share is slowly declining, but so far the actions of the BRICS countries do not pose a major threat to the dollar's position as the most widely used currency. Launching a new BRICS currency is a very complicated and time-consuming exercise.

Is inflation under control?

Since the link to gold disappeared, fixed exchange rates have gradually disappeared. With no link between money and gold, there has been no limit to the amount of money a central bank can create. It has been convenient for governments to borrow almost unlimited amounts of money by issuing debt securities that the central bank then buys. It has worked for decades without inflation accelerating. With the COVID crisis, low inflation was attacked from two fronts, creating shortages of many goods, and governments decided to provide consumers with depressed mortgage rates and huge stimulus payments. This resulted in a wave of inflation around the world. Expectations are now for inflation to fall to 2% year-on-year and stay there.

Could the fall in inflation be temporary?

Yes, a range of new factors are driving inflation. The globalization trend is definitely over. The aim is no longer to produce goods at the lowest possible price. Instead, priority is given to security of supply and ensuring that goods are not produced in a country with which there is some kind of conflict. Ideology now drives policy and an ideological divide has opened up between Europe and the Anglo-Saxon bloc of countries on the one hand, and another bloc of countries led by Russia and China. More and more trade barriers are being erected, increasing the price of imported goods. Environmental requirements also make the production of goods more expensive in some cases. Another component is the increased propensity for conflict that can be seen around the world today. It results in a global military build-up that increases demand for a range of raw materials and components.

Last but not least, many countries are today very highly indebted and today only the Netherlands among the countries of Western Europe meet the conditions for joining the Euro.

They are not following the rules set up under the Stability Pact for the creation of the euro. These rules were set up to create a sound and stable currency. The rules stated that public debt should not exceed 60% of GDP and that the annual deficit should not exceed 3% of GDP. It is mainly the southern member states of the euro, including France, that pose the greatest danger to the euro. The pandemic provided an opportunity to support the European project and a corona fund was established to transfer €750 billion in contributions to EU member states. In essence, countries in the North are paying for countries in the South. These transfers have contributed to stability in these countries. Italy has so far received over €100 billion from this fund, making it the largest recipient. However, this is a temporary solution and a new fund to rescue countries that cannot manage their finances will be very difficult to launch.

An expanded war in Europe is also not a good idea if we are to avoid a Euro crisis. Such a crisis could lead to panic selling of Euros and buying of gold.

Sweden has a debt according to this method of accounting of 31% of GDP: to give some perspective, Italy has a debt to GDP ratio of 137%, the US 123% and finally Japan 263% which is the highest level in the world.

Japan has had a very low interest rate on its debt for the past 35 years because inflation has been almost non-existent. Over the past 10 years, inflation has averaged 0.8%. However, inflation in Japan is now on the rise and is above 2%. One might ask what will happen to the Japanese currency if inflation and interest rates continue to rise? Japan was the first country in the world to eliminate inflation in the 1990s. Will it also be the first industrialized country to enter a downward debt spiral?

If the dollar is to crash
you have to specify against which currency: euro,
krona or yen?

For decades, the issue of a potential crash of the dollar has been discussed. People usually point to the US's large debts. A simple counter question is, against what? What people often don't realize is that a currency's exchange rate is a relative game. If the dollar is going to crash, you have to specify against which currency. Euro, Krona, Yen? The US is the world's largest importing nation. What the US does, other nations tend to imitate. If the US increases its debt, so do other nations. No nation wants their exports of goods to be hurt because of a high rate against the dollar. In Sweden, we have a much lower interest rate than in the US. This helps to keep the krona low and exports up. As long as this continues, the dollar will not crash against any currency other than gold. At the turn of the millennium, gold was trading at a low of 252 dollars per ounce. Today, gold is trading at over USD 2 400. So the rise has been almost 1,000%. Another way of looking at it is that currencies are becoming less and less valuable as more and more money is printed to finance the large government deficits.

[1] https://www.statista.com/statistics/299609/gold-demand-by-industry-sector-share/

[2] https://www.providentmetals.com/knowledge-center/precious-metals-resources/world-gold-production-consumption.html

[3] https://www.gold.org/goldhub/data/gold-etfs-holdings-and-flows

[4] https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2024/central-banks

[5] https://www.statista.com/statistics/264628/world-mine-production-of-gold/

[6] https://www.worldbank.org/en/archive/history/exhibits/Bretton-Woods-and-the-Birth-of-the-World-Bank

[7] https://www.riksdagen.se/sv/dokument-och-lagar/dokument/proposition/kungl-majts-proposition-nr-172-ar-1956_EH30172/html/

[8] https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2024/central-banks

[9] https://www.gold.org/goldhub/gold-focus/2024/05/chinas-gold-market-april-investment-demand-remained-strong

[10] https://en.wikipedia.org/wiki/Gold_mining_in_China