Goldman Sachs: A Beginner's Guide to the Gold Market

Goldman Sachs redefines the analytical framework for the gold market: The traditional supply - demand model is ineffective. 70% of gold price fluctuations are driven by the capital flows of "committed buyers" such as ETFs and central banks. Gold is essentially a "hedging tool against institutional credibility."

On August 19th, according to news from the Chase Trading Desk, Goldman Sachs' one - year summary report of its "primer" on the gold market fundamentally redefines the analytical framework for the gold market. It believes that the traditional supply - demand model is not applicable to the gold market, and price drivers come from the capital flows of "committed buyers."

Goldman Sachs proposed the "Three Conviction Bucket Model" in the summary report, which subverts the traditional supply - demand analysis. The capital flows of three types of "committed buyers" - ETFs, central banks, and speculators - tracked by this model explain 70% of monthly gold price fluctuations.

Goldman Sachs said that every 100 - ton net purchase by "committed buyers" (ETFs, central banks, speculators) corresponds to a 1.7% increase in the gold price. Emerging - market buyers play the role of "opportunists," providing price support but not determining the trend.

The bank also pointed out in the report that, unlike consumer goods such as oil, gold is hardly consumed but stored. Almost all of the approximately 220,000 tons of existing gold globally has been preserved to date. Goldman Sachs emphasized that gold is essentially a "hedging tool against institutional credibility" rather than a simple inflation hedge.

Subverting the traditional supply - demand model, "committed buyers" dominate the price direction

Goldman Sachs proposed an innovative "Three Conviction Bucket Model" in the summary report, dividing market participants into two categories: "committed buyers" and "opportunistic buyers."

"Committed buyers" include ETFs, central banks, and speculators. They buy gold based on macro - economic or risk - hedging judgments. They don't care about the price but only whether the strategy is right. They determine the trend direction of the gold price. Opportunistic buyers are mainly emerging - market households. They care more about whether the price is cost - effective and only make a purchase when the gold price drops to an attractive level (and usually don't sell after buying).

The core logic of this model is that the higher the ratio of net conviction purchases to mine supply, the greater the upward pressure on the gold price. Since mine supply is stable, changes in the net purchases of "committed buyers" almost explain all monthly price fluctuations.

Therefore, through the model, Goldman Sachs found that the capital flows of "committed buyers" explain 70% of monthly gold price fluctuations, and every 100 - ton net purchase corresponds to a 1.7% increase in the gold price. Goldman Sachs also pointed out that opportunistic buyers mainly affect the amplitude of price fluctuations rather than the trend direction.

How to predict the behavior of the three types of "committed buyers"?

Goldman Sachs elaborated on the methods to predict the behavior of various "committed buyers" in the report. In summary:

Regarding ETFs: They are closely related to U.S. policy interest rates. A 25 - basis - point interest rate cut brings about 60 tons of ETF demand within six months. Changes in ETF holdings are slow and sensitive to interest rates, and will exceed the level implied by interest rates during economic recessions or crises.

Regarding central banks: Their gold purchases feature long - term cycles. They increase their gold holdings when the currency neutrality (concerns about fiscal sustainability) or geopolitical neutrality (sanction risks) of reserve assets is questioned. After the freezing of the Russian central bank's reserves in 2022, the purchases of emerging - market central banks increased five - fold.

Regarding speculators: They are considered "hot money," fluctuating around the long - term average and tending to revert to the mean. They are regarded as "noise" around the fundamental value.

Specifically:

1. ETF demand: Western long - term capital sensitive to interest rates

Goldman Sachs data shows that the holdings of gold ETFs are about 3,000 tons, and their flows are significantly sensitive to interest rates and show a lag. The key features are as follows:

A 25 - basis - point interest rate cut by the Federal Reserve brings about 60 tons of ETF demand within six months;

ETF capital flows are not forward - looking and only turn after an actual interest rate cut;

During economic recessions or market stress, ETF holdings will continuously and significantly exceed the level implied by interest rates.

Goldman Sachs said that the well - known "interest rate - gold" relationship mainly stems from the high negative correlation between ETF holdings and interest rates. The "breakdown" of this relationship after 2022 actually reflects a five - fold surge in central bank gold purchases, overriding the impact of ETF outflows.

2. Central bank gold purchases: A long - term geopolitical hedging tool

Goldman Sachs said that central bank gold demand shows long - term cycle characteristics. When the neutral status of alternative reserve assets is questioned, net purchases tend to be active. Historical driving factors include:

Concerns about currency neutrality: Fiscal sustainability issues;

Geopolitical risks: Threats of sanctions.

After the 2008 financial crisis, central banks switched from being net sellers to net buyers. After the freezing of Russia's $300 billion in reserves in 2022, emerging - market central bank gold purchases soared to nearly 1,000 tons per year, a five - fold increase from the previous level.

Goldman Sachs built an "instant prediction model" for central bank gold purchases using UK customs data to capture unreported official purchase activities. The model includes: Direct exports of gold bars from the UK to non - Swiss countries (representing direct shipments to central bank vaults); Differences in UK - Switzerland trade data (reflecting central bank demand transshipped through Switzerland).

3. Speculative positioning: Noise around the fundamental value

Goldman Sachs regards speculative positions (COMEX net long managed funds) as "hot money," fluctuating around the fair value anchored by slow - moving funds such as ETFs and central banks. There are three main patterns:

• Position - building in anticipation of events: A "waiting - room" allocation before major uncertain events, such as the 2016 UK Brexit referendum and the 2024 U.S. presidential election;
• News sensitivity: Due to their "hot money" nature, they react quickly to news that changes expectations of uncertainty;
• Forced liquidation driven by margin calls: When the stock market plunges, the liquidity of gold makes it a source of funds, causing an initial decline in prices and positions.

Gold is a store of value and essentially a hedging tool against "institutional credibility"

Goldman Sachs emphasized the fundamental difference between gold and other commodities in the report. Almost all of the approximately 220,000 tons of gold mined throughout history still exists, and the annual new production only accounts for about 1% of the existing stock.

Goldman Sachs believes that, unlike consumable commodities such as oil, gold is not consumed but stored. Currently, the main constraints on the supply side of the gold market include:

The labor - and energy - intensive nature of gold mining results in high fixed costs;

Mines cannot simply "increase production" during a bull market, as production capacity is limited by plans made years ago and safety restrictions;

The globally dispersed mining pattern means that local disruptions have limited impact on the overall supply;

The ore grade is continuously declining. In the 1950s, 12 grams of gold could be extracted per ton of rock, but now it's only 3 grams.

Goldman Sachs said that these structural supply constraints are the fundamental reason why gold has achieved its status as a store of value, and these structural characteristics render the traditional supply - demand balance model ineffective in the gold market.

Finally, Goldman Sachs clarified the misunderstanding of gold as an inflation - hedging tool in the report. Goldman Sachs said that gold is essentially a "hedging tool against institutional credibility" rather than a simple "inflation - hedging tool."

Goldman Sachs believes that gold performs well in certain specific inflation shocks - those accompanied by a decline in institutional credibility. That is, when the market starts to doubt the central bank's ability or willingness to control inflation, hyperinflation may occur, bonds and stocks will decline significantly, while the price of gold will rise.

The 1970s in the United States is a typical example: The U.S. carried out extensive fiscal expansion and the Federal Reserve was forced to cooperate with fiscal policies, resulting in out - of - control inflation. Investors no longer trusted the traditional financial system and turned to "off - system" value - preservation tools - that's why the price of gold soared.

In a typical inflation cycle in developed markets, the credibility of the central bank and long - term inflation expectations usually still exist. The central bank will raise interest rates to suppress price increases. Higher interest rates increase the opportunity cost of holding gold and also reduce the investment demand for gold ETFs. In this situation, gold usually performs poorly.

This article does not constitute personal investment advice and does not represent the views of the platform. The market is risky, and investment should be made with caution. Please make independent judgments and decisions.

This article is from the WeChat official account "Wall Street Insights". Author: Dong Jing. Republished by 36Kr with permission.