Could gold fall further in 2023?

Gold is trading at $1877.54 per ounce at the time of writing, down by some -1.22%. traders are worried that the precious metal could fall further in the remainder of 2023. It is worth noting that gold demand in China has surged in 2023, with a 16% increase compared to last year but only 4% year-to-date. This is surprising as gold is primarily driven by real interest rates, which account for inflation.

Although gold is believed to be able to keep its value over the long term, investors must pay for it up front in order to own it. If you can make a meaningful return by investing in a secure government bond, gold becomes less appealing in comparison. However, during the past year or so, the two have become independent of one another, with real rates on US 10-year Treasuries increasing this year and reaching levels last seen in 2009.

The Shanghai premium, where gold bullion bought in China sells for greater rates than the worldwide price, is another intriguing phenomenon now occurring in the gold markets.

There are murmurings about de-dollarisation, the notion that China, Russia, and other emerging countries would like to switch from a financial system dependent on the US dollar to one more conducive to their political dominance.

The soaring demand for gold is the latest sign of economic anxiety in China, as domestic sales of gold bars and coins rose by 30% in the first half of 2023. Given that the Chinese currency, the yuan, has weakened sharply during 2023, and a weak property market could mean that housing is no longer the go-to asset for sheltering wealth, this capital flight argument makes sense.

From a Chinese investor’s point of view, gold is an effective way to get wealth “out of the country” while still being in the country. Gold does face headwinds, but there is no guarantee that they will continue to rise. If markets return to the “old new normal” and inflation is genuinely transitory and now beaten, then rates will end up coming down.

If inflation is now going to be a more persistent thorn in the economy’s side, then a great deal depends on the vigour with which the Federal Reserve tries to squeeze it out of the system.

It is worth having gold as a small part of your asset allocation as portfolio insurance either way, as it tends to rise in periods of panic. However, it doesn’t strike me as particularly cheap right now either.

To give higher conviction, seeing a turn in the US dollar or US real rates would help. However, some observers do suggest that markets probably will not be in a more bullish environment for gold until it becomes clearer that inflation will be an ongoing issue.