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Emerging market central banks represent new demand for gold as they de-dollarize - Société Générale

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(Kitco News) - Although rising real interest rates will continue to create a challenging environment for the gold market, analysts at Société Générale see some potential for the yellow metal as an important diversifier for central banks.

The French bank is specifically looking at non-OECD central banks as some nations look to diversify away from the U.S. dollar.

The U.S. dollar's role as the world's reserve currency has been in focus since Russia's invasion of Ukraine. In response to the conflict, the U.S. and Western allies have applied significant economic sanctions on Russia, effectively weaponizing the U.S. dollar.

The analysts said that central banks in developed western nations already have substantial gold reserves. For example, they noted that Banco de Portugal's gold holding represented more than 72% of its foreign reserves.

In contrast, SocGen noted that, on average, emerging market central banks hold about 3% of their reserve assets in gold.

"The current freeze of some of Russia's central bank reserve assets highlights the risks inherent in some USD-based holdings, including Treasuries, in a context in which most central banks have expressed a wish to 'de-dollarize'their asset allocations. From low starting points, non-OECD countries have increased their gold holdings, but remain significantly underinvested compared to OECD countries," the analysts said.

In its latest multi-asset portfolio strategy, SocGen recommends a 5% allocation to gold.

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"If our reasoning proves right and non-OECD central banks increase their gold holdings by, let's say 5% – in theory, they could go much higher given their current very low weighting versus OECD central banks – that would represent the equivalent of 475 tonnes of gold, or 13% of 2021 gold production.

SocGen appears to be relatively neutral on gold in the near term as they note that the Federal Reserve's aggressive rate hikes are pushing real interest rates higher. However, at the same time, they highlighted rising inflation as a positive factor for the precious metal.

"While there may be occasional spikes as geopolitical tensions unfold, fundamentally we are not bullish on year-end gold prices as real yields should be supported by the Fed's tightening," the analysts said. "That said, real yields (UST yield minus CPI) could stay negative until the U.S. enters its next recession, lowering the opportunity cost of gold for investors with a longer time horizon."

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