By Michael Smirnow, Chief Investment Officer, Arabian Gulf Capital
Gold is often discussed as a response to political instability or the latest move in the dollar. We suggest a
more structural investment case. We hold gold strategically at 3% to 5% of a portfolio, through the cycle
rather than as a short-term trade. Central-bank demand provides the floor, Western investor demand
provides potential upside, and real yields are the principal trigger for those flows.
The distinction matters in the current economic regime. Supply shocks can cause equities and bonds to
fall together, weakening the role long-duration government bonds once played in balanced portfolios.
We have therefore moved part of our hedging away from duration and into gold and alternatives. We
size gold against the job it performs as portfolio insurance, rather than against a single price forecast.
Central-bank purchasing has changed the demand base. Central banks bought more than 1,000 tonnes
in three of the four years through 2025, compared with an average of 473 tonnes in the previous
decade. The second quarter of 2026 was the strongest second quarter on record. Total demand
remained flat year on year even though gold was 37% more expensive, suggesting that a meaningful
part of demand remains relatively insensitive to price.
Poland added 82 tonnes in the first half, and China added 40 tonnes, its largest quarterly addition since
2023. The World Gold Council expects central-bank purchases in 2026 to finish below the 863 tonnes
recorded in 2025 but still far above the norm that prevailed before 2022.
The reported figures require care. First-quarter central-bank buying fell from 244 tonnes to 57 tonnes
after unreported purchases were reclassified. The 187-tonne adjustment was larger than most quarters
of exchange-traded-fund demand. The episode shows that central-bank data can be less reliable than it
first appears, even when the underlying structural demand remains supportive.
Western investors play a different role. Central banks provide the structural floor because their
purchases appear relatively insensitive to price. Western investors, by contrast, are the swing buyer:
their ETF flows can provide the next source of upside, and those flows respond more directly to real
yields. A higher real yield increases the opportunity cost of holding gold because the metal pays no
income. When real yields decline, that cost falls, making gold relatively more attractive and potentially
drawing Western investors back into the market.
This is why the current level of real yields is also central to the investment case. At 2.42%, the ten-year
real yield stands only 47 basis points below its post-2003 high but 165 basis points above the average of
the last decade. Put differently, real yields are much closer to the top of their historical range than to
their recent average, leaving considerably more room below than above. The World Gold Council
identifies 2.5% as the level traditionally associated with a higher opportunity cost for holding gold. With
the real yield now close to that threshold, a decline would reduce that opportunity cost and could
become the trigger for renewed Western ETF demand.
History does not make the relationship mechanical, but it provides useful context. Gold rose during the
twelve months following three of the last four peaks in real yields, with a median gain of 29%. The
exception occurred when the peak was below 1%. The two closest comparisons to today were also the
most favourable: after the October 2023 real-yield peak of 2.52%, gold rose 38% in a year, while the
November 2008 peak of 3.15% was followed by a 51% rise.
The mechanism is also visible in investment flows. Global gold ETFs received about $8 billion in the first
half, even as North America recorded a $7.7 billion outflow, its weakest first half since 2013. Gold
holdings reached a record 4,176 tonnes in June, and Western ETF flows turned positive in July. These
investors remain the main source of additional demand if real yields begin to decline.
Higher prices are having their clearest effect on jewellery. Fabrication declined 12% in the second
quarter, and consumption fell 17%, even as the value spent increased 22%. Buyers purchased less gold
at higher prices, but that decline did not offset demand elsewhere.
Gold is roughly flat on the year after giving back its war premium. That supports the view that real rates
influence it more consistently than geopolitical headlines. The argument is directional rather than
mechanical, and the relationship between gold and real yields has ranged from strongly negative to near
zero over rolling twelve-month periods. Even so, the structure of the market is clear: central banks
provide the floor, while Western ETF flows offer potential upside if real yields decline. Combined with
the reduced reliability of bonds as an equity hedge, these forces support a strategic allocation to gold.
Arabian Gulf Capital AGC holds a Category-1 Investment Firm licence issued by the Central Bank of
Bahrain and provides tailored investment solutions to individual, corporate and institutional clients.
