Source: Bloomberg and Sprott Asset Management LP. Data as of June 30, 2023.
The bearish sentiment that was anticipated in the first half of 2023 did not occur for several reasons: 1) as potential risks faded, realized volatility collapsed, causing massive buying from systematic funds; 2) an earnings recession failed to materialize; 3) U.S. Federal Reserve actions to protect bank depositors reaffirmed the"Fed put"10 despite interest rate hikes; and 4) the promise of artificial intelligence sparked an equity bull market.
We believe that central banks are now the main drivers of the long-term price of gold, while investment funds are the main drivers of short-term price swings. Since mid-2022, central bank buying has been substantial and comparable to levels last seen in the 1970s. Central banks will increasingly seek outside money, and we believe gold is the most prominent and liquid option. China in particular has promoted using the RMB as a trade and reserve currency. However, the RMB has limited liquidity, operates within a closed capital system, has a soft peg to the U.S. dollar and is limited to the purchase of Chinese goods.
The IMF estimates that gold represented just 7% of estimated central bank reserves at the end of 2021. Moves to increase these gold holdings make central banks the price setters for gold. For example, large-scale central bank gold buying over the nine months from Q3 2022 through Q1 2023 amounted to 1,092 tonnes or ~0.50% of total central bank reserves. China could be another gold price driver as it invoices more of its commodity trade in RMB and needs to build gold reserves for convertibility.
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