Gold Getting a Boost from the "Debasement Trade"

Gold is being boosted by a “debasement trade,” and according to JPMorgan analysts, this dynamic “may have legs.”

Gold has been pushed to record highs in recent weeks. A weakening dollar and lower real bond yields have created tailwinds for the yellow metal. However, according to a team of JPMorgan strategists led by Nikolaos Panigirtzoglou, the gold price has climbed above what should be expected, given these factors.

“This increase in gold prices is influenced by a 4-5 percent decline in the dollar and a significant drop in real U.S. Treasury yields by 50-80 basis points. However, the appreciation of gold has exceeded what these factors alone would suggest, indicating a re-emergence of the ‘debasement trade.’”

Broadly speaking, a debasement trade strategy involves buying assets investors believe will protect value during periods of currency debasement caused by inflationary monetary policy. Investors who expect currency debasement often seek refuge in assets that retain value or hedge against inflation – including precious metals.

In a debasement trade, the goal is to preserve and possibly grow wealth by taking advantage of a weakening of the currency. Gold is an excellent debasement trade asset because it historically holds or gains value during periods of inflation or currency debasement. 

Given the recent supersized rate cut by the Federal Reserve and the pivot toward looser monetary policy by other central banks around the world, a debasement trade strategy makes sense. 

The JPMorgan analysts describe some of the factors driving the current debasement trade in gold.

"The 'debasement trade' is a term that reflects a combination of gold demand factors which in our client conversations range from structurally higher geopolitical uncertainty since 2022, to persistent high uncertainty about the longer-term inflation backdrop, to concerns about 'debt debasement' due to persistently high government deficits across major economies, to waning confidence in fiat currencies in certain emerging markets, and to a broader diversification away from the dollar." 

The analysts specifically pointed out the declining share of dollars in currency reserves. According to their review of IMF data, dollars made up 57 percent of reserves in the third quarter, down from 58.2 percent in Q2. 

As of 2002, dollars accounted for 72 percent of global reserves.

This indicates a growing wariness of the dollar due to several factors, including the rapidly increasing U.S. debt, inflationary policies by the Federal Reserve, and the weaponization of the dollar. 

Meanwhile, gold’s share of global reserves has grown. According to Bank of America analysts, gold has overtaken the euro as the second-largest reserve asset.

Central banks have gobbled up gold over the last several years. Central banks globally added a net 483 tons of gold through the first six months of this year, 5 percent above the record of 460 tons in H1 2023, and aggressive buying has continued in Q3. Last year, central bank gold buying of 1,037 tons fell just 45 tons short of 2022’s multi-decade record.

“There is little doubt that the pace of central bank purchases is key to gauging the future trajectory for gold prices,” the JPMorgan analysts said. 

Analysts at ANZ Bank recently said they expect central bank gold buying to remain hot for at least the next six years. According to these analysts, "Depleted trust in the U.S. fixed-income assets and the rise of non-reserve currencies are other themes that could support central bank gold buying." 

With geopolitical tensions not likely to ease any time soon, uncertainty surrounding the U.S. presidential election, and the prospects of more monetary easing in the months ahead, JPMorgan analysts expect the debasement trade to continue in the near term and possibly accelerate.

********