By Juan Carlos Artigas. Content sourced from the World Gold Council
- Rising rates and a strong dollar have had a significant negative effect on gold’s performance despite support from geopolitics and inflation
- We believe gold’s headwinds may start to subside while supportive factors will likely remain, thus encouraging demand for gold as a long-term investment hedge
Many of the investors we talk to feel that gold’s performance should be much stronger considering multi-decade high inflation across the world. Yet, what may not be evident to everyone is that gold has outperformed most major assets so far in 2022 (Chart 1). In fact, gold has done much better than inflation-linked bonds both in the US and elsewhere. And we believe that gold’s performance so far this year reflects the behaviour of its underlying drivers.
Chart 1: Gold has been a top-performing asset so far in 2022*
*As of 21 September 2022. Based on Bloomberg Commodity Index, US Dollar Spot Index, BofA US 3-month Treasury Bill Index, LBMA Gold Price PM, Bloomberg US TIPs Index, Bloomberg US Agg Bond Index, Bloomberg Global Agg Bond Index, S&P 500 Index, MSCI World Index, Bloomberg Global Inflation-linked Agg Index, MSCI EM Index and NASDAQ Composite Index between All calculations are in USD.
Source: Bloomberg, ICE Benchmark Administration, World Gold Council
Let us expand. Gold is generally driven by four key drivers: economic expansion; risk and uncertainty; opportunity cost; and momentum.
In 2022, gold has been supported by greater risk and uncertainty, the most obvious coming from geopolitical tensions. High inflation has also been a contributing factor – but not all investors have perceived the inflation risk in the same way. This is most clearly seen by the stark difference between US CPI and long-term inflation expectations implied by the bond market (Chart 2). In short, while inflation has been high, US bond investors believe that the Fed will do whatever is necessary to bring inflation down and will do so effectively. Not all investors may agree.
Chart 2: Bond investors expect the Fed to effectively bring inflation down*
*Data as of 31 August 2022. Based on US CPI y-o-y and US 5yr-5y forward breakeven rate (as implied by the difference in real and nominal forward yields).
Source: Bloomberg, World Gold Council
Gold has also had to contend with much higher opportunity costs: both from continuously increasing interest rates and the strongest US dollar for 20 years.1 A commonly used simple (but reductive) model for gold – based solely on real rates and the dollar – suggests that gold should have fallen by more than 30% thus far (Chart 3). Further, our Gold Return Attribution Model (GRAM) indicates that negative investor sentiment, with heavy gold ETF outflows and weak positioning in the futures market, has put additional pressure on gold. Weak Chinese demand earlier in the year did not help either.
The fact that gold has performed as well as it has, all things considered, is a testament to its global appeal and more nuanced reaction to a wider set of variables.
Chart 3: The gold price would’ve been much weaker if it were solely determined by interest rates and the dollar
*As of 31 August 2022. Model estimated using OLS, in levels, using data from Jan 2007 to August 2022.
Sources: Bloomberg, ICE Benchmark Administration, World Gold Council
Looking forward…
We believe that both interest rates and the dollar still pose risks for gold.
Despite a sluggish start, central banks have acted aggressively to curb rising inflation. The US Fed delivered another 75bps hike last week, bringing its Fed funds target rate to 3.25%. And dot-plot projections suggest they may deliver an additional 75-125bps by year end. Similarly, the Bank of England increased its target rate by an additional 50bps and the Swiss National Bank by 75bps. Other central banks will likely follow suit.
With central banks playing catch up, the frequency and magnitude of these decisions has resulted in markets being more sensitive than usual to monetary policy – and gold has been no exception.
However, we are cautiously optimistic. For one, given how much tightening has occurred so far, we would expect rate hikes to slow down, allowing some of gold’s other supporting factors to play a more important role. Also, the fact the other central banks are being more resolute in their policy decisions – partly to curb inflation, partly to defend their currencies – should weigh on the US dollar.
Further, positioning in gold futures has turned net short again and this, historically, has not lasted long – often mean reverting in subsequent weeks. At the same time, central bank demand for gold remains quite strong. Finally, as recessionary and geopolitical risks increase, 2 investors may shift to more defensive strategies, looking for high quality liquid assets such as gold to reduce portfolio losses.
Footnotes
1. For example, in the 1970’s, in addition to rising inflation, gold was also supported by a weakening dollar
2. Volodymyr Zelenskyy says Russia ‘wants war’ in rebuke of troop mobilisation | Financial Times
This article is a re-post from here.
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7 Comments
Officebound,
Absolutely. I would have thought that the current conditions were just what gold needed to shine, but all it has done is fall less than other asset classes. As it produces no income, I don't find that at all attractive. I much prefer my income producing NZ shares with most showing an increased dividend this year. That their price has fallen is immaterial as it is market related, not company specific.
I expect a return on my investments, so have never had any interest in gold.
It should be fairly obvious.
Gold is a shiny rock, with a historical cultural value ascribed to it. It's kinda rare, so you can't easily print more. For many years, it was the de facto safe store of value.
In the face of crypto, or moonshot unicorn shares like Tesla or Gamestop, it's become super unsexy. Boringly safe, no upside, no massive spike in value.
Gold is only down against the US dollar. In most other currencies it is up. At the start of covid(2020) it was around $2300, and was close to $2900 overnight NZD. That is 26%. During the same period it is almost flat against the USD. People arent getting rich off gold. But they arent losing their shirt either. A tactical nuke, rise of the European right wing, the collapse of China and Taiwan...all reasons to hold something outside the fiat system. Then there is the UK and Europe's depenence on Russia. Russia and China are driving the direction at the moment through their withdrawal from the global 'play nicely' club. They are also buying gold.
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