Hemisphere Capital Management Inc.

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Gold and Geopolitics

2024 has seen a sizeable jump in the price of gold.  After trending in the $USD 1,800 to 2,000 range for the past three years, the price of gold has increased 20% year to date.

Historically, the price of gold has been a rough hedge against inflation.  Recent post-covid inflation has been a factor in the rise of the price of gold, however, rising geopolitical risks are the primary reason.

When Russia invaded Ukraine in 2022, the Bank of Russia held over $US 300 billion of financial assets outside of Russia.  Most of these funds were mainly held in Belgium at Euroclear.  Euroclear is a financial services company that offers safekeeping and settlement of financial securities. 

These funds still technically belong to the Bank of Russia, however, there have been ongoing discussions amongst Western nations as to whether these assets should be seized and given to Ukraine.  Currently, the funds remain “frozen” and plans are in place to provide Ukraine with the income earned on the assets.

Although these actions are widely supported in Europe and North America, they have cast a dark cloud over the international monetary system.  Central banks of “non-western” countries are extremely concerned about the security of their financial assets held in Europe and America.  Could their central bank assets also be “frozen” or seized if their actions were deemed offside by the US and/or Europe?  Globally, we have a changing view of “trust”.

The Bank of China, as well as Chinese consumers, highlight this worry about US dollar financial assets.  As can be seen in the following chart from the IMF (International Monetary Fund), after the invasion of Ukraine by Russia, China dramatically accelerated its selling of US treasury bonds (generally held by US based financial intermediaries) and increased its direct purchase of gold which is stored in China.  Because, for many years, China has had a substantial trade surplus with the US, China has accumulated a significant holding of US treasury bonds.

Currently, it is estimated that China still owns over $800 billion of US treasuries.  Undoubtedly, in the future, a portion of these funds will be targeted for gold purchases.  Further, with China-Russia trade increasing significantly because of Western sanctions, it is very probable that Russia is using gold for Chinese purchases.  Interestingly, because of strong Chinese demand, it is not uncommon for the spot price of gold to be 3 to 4% higher in China, relative to the London global gold price.

The global momentum to find an alternative to the US dollar for global financial transactions will continue to build.  The US dollar will remain the dominant reserve currency for the foreseeable future, however, the shift by the Chinese and other central banks reflects a desire to diversify and “better protect” their assets.  The currency alternatives (euro, pound, yen) are not particularly appealing as they have the same problem as US assets, they require the financial assets to be held in foreign central banks.  At present, outside of gold and other precious metals, there are no real alternatives.  Gold will likely become more valuable.