What's driving the recent rise in gold prices?

Gold’s best start to the year since 1980 has been good for Josh Saul, a former metals trader who runs a bullion company based next to the Bank of England.

He has had to hire 10 temporary staff to deal with the volume of calls to the Pure Gold Company that he founded three years ago.

“We’ve seen a huge increase in the amount of inquiries and the amount of people looking to remove exposure to equities, banks, bonds and government debt,” he says.

That fear has helped push gold out of a three-year downturn, as prices for the precious metal trade at their highest levels in a year. In contrast, global equities have fallen more than 20 per cent since last May, entering a bear market.

Last year gold slumped as investors fretted about the Federal Reserve’s first rate rise. Now they are focused on the opposite: the prospect of falling and even negative interest rates across the globe.

That has prompted fears of a global economic slowdown and a feeling that central banks have run out of tools to stimulate their economies. For long-term gold supporters it is confirmation that central banks cannot be trusted not to debase a currency in times of crisis. They see gold as a long-term store of value.

“What’s going to sustain it [gold] is a loss of confidence in central banking which is just starting,” says John Hathaway, co-portfolio manager at the Tocqueville Gold Fund with over $800m under management. “What’s going to drive that is falling stocks. Zero interest rates for all these years has pushed up the valuation of a lot of garbage.”

The European Central Bank cut rates to negative inDecember while the Bank of Japan did the same last month. Sweden cut its rates further to minus 0.5 per cent last Thursday while Janet Yellen, head of the Federal Reserve, said it is studying the feasibility of negative short-term rates.

Gold has done better than equities, bonds and a broad commodities index in a low and falling interest rate environment, according to a JPMorgan analysis of data going back to 1975.

Monthly returns for gold averaged 1.4 per cent during periods of low and falling US real interest rates, compared with a long-run average of 0.4 per cent, according to the bank. It expects gold prices to rise to $1,250 by the fourth quarter of this year.

“The move from a perceived ‘low and rising’ real interest rate environment to a ‘low and falling’ scenario would be supportive for gold,” JPMorgan says.

Gold’s recent rise was mostly driven by buyers of gold-backed exchange traded funds, which have seen their second largest inflow of funds in almost six years, according to Bank of America Merrill Lynch. Investors in gold futures on the Comex exchange in the US also doubled their net long positions, which bet on rising prices, in the week to February 9, according to official data.

This time ETF buyers have come from a larger geographical base, according to analysts.

“Previous periods of accumulation were dominated by North American buyers but purchases this year are more evenly distributed globally,” according to HSBC. “This supports the rally.”

The question now is whether the price rally can entice physical gold buyers in India and China, the world’s largest consumers, which accounted for 45 per cent of global gold demand last year, according to the World Gold Council. China was on its new year holiday during last week’s rally.

It will also depend on whether more mine supply comes out of the market, according to Joe Wickwire, portfolio manager at the Fidelity Select Gold Portfolio with $870m of assets under management. Mine production in 2015 recorded its first quarterly decline and its slowest annual growth rate since 2008, according to the World Gold Council.

“The duration of this move in the gold space is really contingent on supply continuing to come down and the gold industry getting more right-sized,” he says. “Because macroeconomics is going to be supportive for a while and the key swing factor is whether supply continues to come down.”

Most analysts caution that such a quick run-up in price is due a correction.

“I don’t think we’re in the middle of a sustained bull market,” David Govett, head of precious metals at London-based broker Marex Spectron, says. “The higher it goes the more it has to run out of steam at some point. It only takes a couple of positive economic figures to switch that mentality around and everyone jumps out of the lifeboat.”

Bernard Dahdah, a London-based analyst at Natixis, who was the most accurate analyst last year as ranked by the London Bullion Market Association, predicts gold will drop to just below $1,000 an ounce later this year if the Fed continues with rate hikes and the global economy recovers.

“If you look at the other fundamentals surrounding gold, I don’t think demand is strong enough to justify a high gold price,” he says. “I don’t think prices are going to stay where they are.”