Gold: Caught In The Crossfire

Amid the Ukraine conflict, attempts by Russia and China to break the stranglehold of the US Dollar as the reserve currency could put gold at the heart of this conflict. Bullion analyst Sanjiv Arole keeps a close eye on recent developments.

World War II saw Blitzkrieg & Pincer attacks added to the war lexicon. Germany overran most of Europe in its blitzkrieg at the beginning of the war in 1939. The war finally ended with Germany being enveloped on its flanks by pincer attacks by the Red army on one hand and the Allied forces on the other side, ultimately resulting in the break-up of Germany into East Germany and West Germany. Coming to the present, Russia failed in the attempt to overrun Ukraine with its Blitzkrieg on 24th February, 2022. However, Russia and China appear to have (by co-incidence) launched a pincer attack on the US dollar in an attempt to protect their currency from hegemony of the USD.

Russia first removed VAT on gold, linked the rouble to gold, announced that it would buy gold till 30th June and then insisted on payment in roubles for gas and oil purchased by European countries. Earlier, China got into talks with Saudi Arabia to trade in Chinese Yuan for Saudi oil. All of which could be engineered to negate the impact of US-led UN sanctions and isolation of Russia from the financial markets.

The long-term goal could be to end the system of dependence on the US dollar for trade purchases, particularly energy bills, prevalent since the 1970s. It could also be yet another attempt to break the stranglehold of the USD as the reserve currency and the most widely used currency in the world. Gold could well find itself at the heart of this main conflict even as the war in Ukraine appears to have been sidelined, but with no end in sight. What would be the impact of all of the above on gold?

The US is the largest economy in the world at over $20 trillion. Moreover, the US dollar dominates as a payment currency for global trade with over 79.5% share of inter-regional currency usage in value. The belief in the US that it would fulfill all its obligations perhaps gives credence to the USD. Then, the US often tends to enforce sanctions by weaponising the USD to preserve its global economic and geopolitical position. In the past, attempts have been made to break the hegemony of the USD on global trade transaction. Libya and Iraq tried to insist on non-USD payment for their crude oil purchases by all. The US used its financial clout as well military might to effectively neutralise the attempts. But, this time it is different!

Russia linked the rouble to gold and announced that it would purchase gold at fixed price of 5000 roubles per gm of gold till 30th June. However, once the rouble strengthened slightly, it abandoned the program. Now, Russia is one of the largest producers in gold (latest year number 331.1 tonnes), the other being China at 368.3 tonnes. Over the last several years Russia has added around 274 tonnes to its already substantial gold reserves of over 2,200 tonnes. China too has added gold regularly to its gold reserves every year. In recent times, Russia has reduced its dollar denominated forex holdings and replacing them with gold or other assets and currencies. Thus, Russia is better prepared for US-led sanctions this time than a few years ago during the Crimea war. It must be remembered that Russia not only has the largest gas reserves in the world, but it is the largest exporter of gas in the world, accounting for around 40% of EU’s gas consumption requirements. Germany (50%), Italy (40%) and France (25%) depend on Russian gas. Apart from that several smaller countries in Europe depend entirely on Russian gas. Although, most European countries defied the Russian diktat to make payments in roubles for gas and oil, most of the big guns made payments in Euros to the Gasprom Bank (not hit by sanctions) to be converted into roubles. Then, Russia is the largest exporter of crude oil after Saudi Arabia in the world and one the largest exporters of wheat and corn along with Ukraine. Moreover, apart from being a top ten economy in terms of purchasing power parity, it is the 4th largest exporter of gold. Russia has a $190 billion trade surplus as well as being the 2nd largest exporter of arms in the world after the US. If push comes to shove and if Russia were to cut off gas supplies to Europe, then, it is highly likely for Europe to blink as there are no immediate alternates to Russian energy supplies. With Russia being a nuclear power, any nuclear war could only happen over Europe. It may not be plausible for US’ European allies to risk that for the US. Thus, Russia is not someone who one can trifle with. Russia is not a pushover nor can be browbeaten by any sanctions. All this could only add to the tensions in the world and lead to uncertain times. All of which augurs well for gold!

China, the silent supporter of Russia at the moment, is the second largest economy in the world at over $17 trillion (at PPP, it is already the world’s largest economy at over $24 trillion). It is the manufacturing hub of the world and has the largest trade surplus of over $600 billion. It has challenged the US as the only superpower in the 21st century. In fact, China has been spreading its influence across Asia and Africa. It appears keen to replace the USD’s hegemony with a basket of currencies, including the Chinese Yuan.

China is a major player in the precious metals market. It is the largest producer and consumer of gold, and a major producer and consumer of silver, platinum and palladium as well. The Shanghai Gold Exchange has been in operation since 2004. It is quite apparent that the combined might of both China and Russia is indeed a formidable adversary for the US.

However, that does not mean that the US will easily let go its fifty year USD’s hegemony in the financial markets. It is still the largest economy in the world at over $20.89 trillion. The USD is used in over 79.5% of all trade transactions in the world. It has the largest gold reserves with the Fed at over 8,133 tonnes. It has strategic oil reserves and is currently offloading a million barrels of crude oil every day. It is the largest exporter of arms in the world and conflicts or war are actually good business for the US. The Achilles’ heel for the US is its huge trade deficit ($859.1billion as of 2021) and its humungous debt of $30.29 trillion as of February 2022. The servicing of this debt is a major stumbling block for the US Fed. However, the political clout that US has with its allies (NATO) usually is instrumental for US to pass UN sanctions against countries.

One thing is obvious from all of the above. There is no quick-fix solution to the issue at hand. Neither can the US hope to quell the dual challenge to the USD from Russia and China nor any military solution to the issue. It could be protracted jostling for position as the USD fights to maintain status quo. There can be no immediate solution in sight.

What is certain is that the gold standard is back in the reckoning, even if it is limited to the Russian rouble at the moment. Whether the gold standard makes a total comeback would depend on many other factors. But, the days of the greenback being the absolute currency of the world appears headed towards sunset, sooner or later. What we could end up with is a basket of currencies with the USD still being a big player. USD’s position could become akin to the position of De Beers in the diamond industry today; as it no longer the monopoly in diamonds it once was, but is still one of the largest producers of rough diamonds.

The gold price last week first crossed $2,000 per ounce mark on 18th April, 2022, albeit very briefly. Thereafter, it has plummeted to around $1,926.50 per ounce, before finally closing the tumultuous week around $1932.30 per ounce. Gold seemed to have been aided as the prolonged Ukraine war intensified again and fears about rampant inflation raised its head as well. Then, the hawkish stand on hiking interest rates taken by the US Fed chairman as well as the European Central Bank (ECB) chief caused the gold price crash. So, what are the main drivers of the gold price now?

Currently, the main drivers of the gold price are geopolitical tensions, rampant inflation, hawkish stance of the Fed, ECB, etc., and the gnawing fear of yet another Covid-19 wave.

The Ukraine war has caused economic and political turmoil across the globe. The IMF and the World Bank have recently revised their growth forecasts made in January 2022 from the earlier 4.4% growth to 3.6%. Already, inflation is showing a rapid upward spiral. There is a growing realisation that the cost of bringing Russia to heel would be too great. Will those who loosened purse strings for Ukraine to fight the war against Russia be equally generous when Ukraine has to be rebuilt?

Moreover, several countries are facing the impact of the war due to higher fuel and food prices. Sri Lanka has defaulted on its payments and France’s Macron faced a tough re-election and won by a slim margin. Most of Europe simply cannot afford if Russia were to turn off the gas taps to Europe. Even the Russian economy could take years to recover. The US could not expect to be immune to the global mess. The aftereffects of the war could singe the world for a long time.

Gold prices could only soar in such a scenario as a safe haven. Then, US inflation has soared from 7.9% to 8.54% as of 31st March, 2022 – already at a 40-year high, it seems slated for further peaks in the wake of the war. The whole world is reeling under higher inflation numbers and that has also affected growth estimates. This could enhance gold’s status as a bulwark against inflation.

There are reports of investors flocking to gold ETFs even as global bourses face uncertain times. Moreover, the hawkish stance of the Fed and ECB to hike interest rates several times in 2022 to curb rampant inflation could halt gold’s charge. In fact, gold is under pressure and losing ground solely due to the harsh interest rate regime announced by central banks and the anticipated stronger dollar in the remainder of the year. But, falling growth rates and high inflation could well trigger off recession or stagflation. These red flags are now not just beyond the realms of possibility, but a real threat for global economy. Last, but not the least is the clear threat of yet another Covid-19 wave engulfing more countries.

As a result, gold prices could soar above $2,100 per ounce in the coming months, if not weeks or days. A hawkish Fed and ECB stance not withstanding!

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