Recently, the media discussed various reasons behind the sharp rise in gold prices. These reasons can first be traced back to the surge in Chinese purchases. As gold prices rose, this discussion also intensified, culminating with “China taking over control of gold prices from the West”, “China's gold buying frenzy caused ETF chaos” and “Chinese consumers surpassing India in the gold buying frenzy”.

Although China's fanatical pursuit of gold is undoubtedly one of the main reasons for the explosive rise in gold, it is not the only driving force: in fact, it all began with the US reaction to the Russia-Ukraine conflict. The “weaponization” of the dollar led to a historic withdrawal of central banks from dollar reserves and a shift to gold, and led to an unprecedented divergence between gold prices and gold ETFs, as the price of gold gradually moved away from financial instruments such as ETFs (which can be easily manipulated by Western banks and the Bank for International Settlements) and determined by physical gold itself.

Central banks' astonishing demand for gold (not the dollar) has reached astonishing levels, and even Goldman Sachs has had to discuss this phenomenon. The bank's commodity analyst Line Thomas (Line Thomas) wrote in a report entitled “Banking on Gold's Geopolitical Upside” (Banking on Gold's Geopolitical Upside) (Banking on Gold's Geopolitical Upside) (Banking on Gold's Geopolitical Upside): “We have proven that central banks have driven up demand for gold since mid-2022, and new geopolitical or financial shocks may push gold up significantly Price.”

Two of the report's most notable highlights are excerpted below:

First, Goldman Sachs shares the view above that central banks, especially those in emerging markets, are driving the gold boom. Since the outbreak of the Russia-Ukraine conflict, central banks around the world have tripled their gold purchases. Although Goldman Sachs warned that “most central banks' gold purchases are unreported,” six emerging market central banks — China, Poland, Turkey, Singapore, India, and Qatar — have all reported net purchases since mid-2022. Of course, this still means that most of the central bank's gold purchases are unreported.

Second, Goldman Sachs believes that geopolitical and financial shocks will drive central bank demand; this is obvious. “Research and history suggest that emerging market central banks buy gold to hedge against geopolitical and financial shocks.” Goldman Sachs wrote and added that based on the US financial sanctions index and US credit default swap spreads, “Our model finds that concerns about geopolitical shocks and the impact on US sovereign debt or the dollar financial system can explain the central bank's gold buying behavior well.”

Goldman Sachs first traced that the price of gold reached a record high of nearly 2,400 US dollars/ounce on April 19, “despite the sharp rise in US interest rates and the US dollar over the past three years, which traditionally indicates a decline in the price of gold.” The bank then focused on central banks because “since mid-2022, central banks' gold purchases have tripled to about 10 million ounces per quarter”, a key characteristic of the new “unshakable gold bull market.”

Afterwards, Goldman Sachs was quick to point out that the central bank's purchase can fully explain the increase in global demand for gold since the second half of 2022, as demand for jewelry has remained stable while investment demand has declined (that is, the sharp drop in ETF holdings indicated above).

Goldman Sachs then simulated the central bank's gold purchases based on the level of concern about geopolitical or financial shocks. Finally, it estimates the possibility that a new geopolitical or financial shock will further boost the price of gold significantly by increasing central bank purchases.

Looking closely at the first point, Goldman Sachs pointed out that the unreported increase in central bank gold purchases fully explains why global central bank gold purchases have tripled since mid-2022, while reported purchases have remained stable. Goldman Sachs cautioned that despite a sharp increase in official gold holdings in emerging markets, there may be room for further growth, as their average share of 6% in official reserves is still about 50% below Germany's 12%.

Next, Goldman Sachs combined research, history, and statistical evidence to show that the central bank bought gold to hedge against geopolitical and financial shocks. The most likely reason behind the boom in gold purchases in emerging markets is: Russia's example vividly shows that if your money is held by other banks or included in the US Dollar Payment System (SWIFT), then it's not really your money. As a result, gold quickly became the preferred form of reserve. History also shows that financial and geopolitical shocks will drive emerging market central banks to buy gold.

Goldman Sachs acknowledged, “Many central banks in emerging markets regard gold as a financial hedging tool because they have already diverted some of their reserves from the dollar after the global financial crisis and subsequent debate on the US debt ceiling.” On the geopolitical side, sanctions, in particular the freezing of central bank assets, often occur at the same time as the price of gold soars:

In 1979, before and after Iran's central bank assets were frozen, the price of gold soared to 2,767 US dollars/ounce (in today's dollar terms);

In 2011, before and after the Central Bank of Libya's assets were frozen, gold rose to 2,472 US dollars/ounce (in today's dollar terms);

In 2014, the first round of sanctions against Russia led to an increase in gold reserves because the Bank of Russia expected a situation similar to Libya and Iran. A board member stated that gold cannot be “arrested or frozen”;

In 2022, freezing the Bank of Russia's assets prompted many central banks, including Poland, to rethink what they consider risk-free assets; Bank of Poland Governor Grapinsky pointed out that gold still has enduring value even when ties with the global financial system are cut. The Bank of Poland plans to increase its gold holdings from 13% to 20% by 2025.

Next, Goldman Sachs built a model for global central banks to buy gold based on concerns about sanctions and concerns about financial and geopolitical shocks. It uses the US 5-year CDS spread to represent concerns about an impact on US sovereign debt or the broader global financial dollar system. Since the 2023 debt ceiling and the US regional banking crisis, US CDS interest spreads are still significantly larger than the 2014-2021 period. This may be due to the huge US structural budget deficit, high interest rates, and uncertainty in post-election fiscal policy.

The bank found that the US CDS interest rate spread, which represents financial fears, and the sanctions index, which represents geopolitical fears, had a very significant positive impact on gold purchases by central banks around the world. Using this model, Goldman Sachs can quantify the room for gold prices to rise in an unfavorable geopolitical and financial situation.

Goldman Sachs concluded that the benchmark price target for gold by the end of this year is 2,700 US dollars/ounce (up 17%), driven by strong demand from emerging market central banks, Asian households, and lower US interest rates. But this is just the beginning: based on the bank's central bank's gold purchase model, and Goldman Sachs's previous estimates of the price elasticity of gold supply and demand, Goldman Sachs estimates that under two hypothetical scenarios, its benchmark gold price forecast will rise:

First, Goldman Sachs estimates that if the US financial sanctions index further shows an increase equivalent to the increase since 2021, then against the backdrop of the central bank increasing purchases of 7 million ounces per year, the price of gold will rise by an additional 16% (to $3,330 per ounce). This increase in the US Financial Sanctions Index is equivalent to assuming that the US adds about two or more financial sanctions against China, or six additional financial sanctions against India.

Second, according to Goldman Sachs estimates, if the US 5-year CDS interest rate widens by one standard deviation (13 basis points), the central bank buys an additional 6 million ounces of gold each year, and the price of gold will rise by an additional 14% (to 3,080 US dollars/ounce). The increase in US CDS interest spreads by 13 basis points will be similar to the increase before and after the US debt ceiling debate in the first quarter of 2023, and will cause the CDS level to be similar to the CDS level during the 2011 debt ceiling crisis.

As can be seen between the lines in this shocking latest report, Goldman Sachs is likely seen as urging its customers to buy gold. After all, if gold actually rises from the current $2,350 to $3,100, its return will far exceed Goldman Sachs' stock market predictions. The bank expects the S&P Index (S&P) to actually remain unchanged at 5,200 points at the end of the year. This is why in the Goldman Sachs report's conclusion:

“To be clear, the geopolitical, fiscal, and financial prospects and their exact impact on central bank gold demand and gold prices are all highly uncertain. Nevertheless, our research highlights the hedging value of gold in unfavorable geopolitical or financial situations, where equity portfolios may be affected.”

Considering that just ten years ago, people thought that expecting gold to soar was the pinnacle of conspiracy theory (The Wall Street Journal says gold is just a “pet stone”), the fact that Goldman Sachs is now actively telling its customers that gold has been transformed into the best hedge against systemic shocks is indeed a revolutionary development.