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Gold staged a surprising rally last week, reaching all-time highs above $2,200 an ounce. The surge has added around 10% to gold’s value since mid-February and is the result of several powerful forces aligning in bullion’s favor. The Federal Reserve’s indication of possible rate cuts, central bank demand for gold, and a weaker U.S. dollar are some of the key factors driving the rally.

The Federal Reserve’s signal of potential rate cuts has cooled real yields, making non-interest-bearing gold more attractive. Futures markets now predict a 72% chance of a rate cut as soon as June, up from 65% before the Fed meeting. This dovish stance by the Fed, coupled with other factors, has led to a surge in gold prices that some experts believe is textbook price action.

Central banks’ insatiable appetite for gold is also fueling the rally, as more developing countries join the de-dollarization movement in response to Western sanctions on Russia. China, in particular, has been consistently adding large amounts of gold to its reserves for the past 16 months. Overall central bank buying reached record highs in 2022 and shows no signs of slowing down, offsetting the selling pressure caused by gold-backed ETFs.

The rise in gold prices has significant implications for luxury jewelry demand, as the cost of gold is a key input for jewelry and watch manufacturers. In China, the world’s largest buyer of gold jewelry, retail sales in the luxury category rose just 5% year-over-year in the first two months of 2024 despite the reopening boom. This could impact luxury conglomerates like Richemont and LVMH, which were hoping for a strong Chinese bounce-back to drive sales higher.

Despite the challenges in the luxury jewelry market, overall luxury spending by Chinese consumers rebounded strongly in 2023 as the country emerged from Covid lockdowns. Bain & Company estimates that Chinese luxury purchases within mainland China recovered to 70% of pre-pandemic levels last year, with tourism spending in Europe and Asia also seeing a comeback. The firm projects mid-single-digit growth for China’s luxury market in 2024, driven by the nation’s robust fundamentals for high-end consumption.

For investors, the recommendation is to allocate 10% of their portfolio to physical gold and high-quality gold mining stocks. The same factors that have contributed to gold’s current bull market, such as lower real rates, central bank buying, and safe-haven appeal, are expected to remain in place in the months and years ahead. Despite near-term volatility, China’s wealthy middle class is likely to continue driving demand for luxury goods and services, presenting opportunities for investors in the gold market.

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