Gold's Secular Drivers Strengthen Amid Inflation and Debt Fears

The case for investing in gold is becoming increasingly compelling, despite its impressive performance so far. Investors are now recognizing the valuable role that gold can play in asset allocation, after being underappreciated for decades.

A recent report by UBS found that family offices allocated a mere 2% of their strategic assets to gold over the past five years, a number that hasn't changed significantly since then. In contrast, Bridgewater Associates' founder Ray Dalio suggests allocating between 5-15% to gold, while Morgan Stanley recommends an even larger allocation of 20%, which would effectively replace half of traditional bond holdings in a 60% equity/40% bond portfolio.

The secular drivers for gold are becoming stronger, with persistent inflation and government debt taking center stage. The US has experienced above-target inflation since 2021, marking the fifth consecutive year, and the Fed's forecasts suggest that it won't reach target until 2028. This reluctance to hike rates is underscored by the difference between the current Fed Funds rate of 3.50-3.75% and a simple monetary policy rule suggesting interest rates should be at least 100bps higher at 4.6%.

Fiscal dominance appears to be at play, with governments running persistently large budget deficits and debt levels rising sharply since the GFC. The US Treasury Secretary's announcements of increasing buybacks for 10-20 year and 20-30 year bonds suggest that the interest bill is now exceeding defence spending.

Central banks have turned net buyers of gold in 2009 and have remained persistent buyers ever since, with trends remaining favorable. A recent survey by OMFIF found that a net 30% of reserve managers expect to increase their gold allocation over the next 12-24 months, while another survey reported 43% of central banks expecting to increase their own gold reserves.