ANZ's analysts see gold with bullish momentum after the US Fed pauses its hiking cycle

By Daniel Hynes and Soni Kumari*

Highlights

• Strong US economic data and consequent repricing of the Fed’s terminal rate will drive the gold price in the short term.

• We expect the Fed will pause its interest rate hiking cycle this year. This should lower the USD and leave US real yields intact, then lift gold prices in coming quarters.

• Technically, bullish momentum is continuing after breaking the range of USD1,845-1,850/oz on Friday. Gold needs to trade high to continue this momentum.

Our view

Gold prices will follow the shifting market expectations of the Fed’s terminal rate. A repricing above 5.5% could be a downside risk in the short term, but it will not be a game changer.

We still hold a bearish view for the USD in 2023 and think its upside could ultimately be capped by the relative outperformance of the US against other economies. A weakening greenback will be a key tailwind for gold prices.

We believe the backdrop is turning supportive for investment demand, after aggressive rate hikes resulted in net outflows in 2022. A pause in the interest rate cycle, a weaker USD and safe haven buying in the face of rising economic risks will all support investor appetite.

We see limited downside, with a 0-3mth target of USD1,800/oz. We have lifted our year-end forecast by USD100/oz to USD2,000/oz.

Conventional gold’s driver coming into play

Gold’s negative relationship with real rates has been weakening over the past few years. The historical sensitivity has fallen from 13% for every 100bp increase in US 10y real yields to 3% and 1% since 2018 and 2020, respectively. In 2022, the 10y real yield rose by 260bp, while gold was largely unchanged. Negative macro factors of rising yield were offset by strong purchases by the central banks and physical demand last year.

Nevertheless, the negative beta of real yields will come into play this year. Gold is now closely tracking the move in real yields this quarter as other factors like geopolitical risks have faded.

Gold has recently come under pressure amid shifting market expectations around the Fed’s terminal rate. Stronger economic data and persistently high inflation are raising the risk of further aggressive rate hikes. We see shifting policy rate expectations being an important factor in the outlook for gold.

Short-term volatility, but upside bias remains intact

US economic momentum (employment and consumption) is proving to be stronger than we anticipated, which could see inflation higher for longer. To return inflation to target, the Fed may need to push the terminal rate higher. This leaves an upside risk to our current federal fund rate (FFR) forecast of 5.5% by the end of Q2. Such repricing of market expectation could be a short-term headwind for gold prices.

The relative performance of the US against other major economies will drive the US dollar moves. Improving fundamentals across other major economies could limit the greenback’s upside. Our DXY forecast trajectory remains unchanged, and has the index falling to 98 by end of the year. This will be a tailwind for the gold market.

We believe recalibration of market expectations around the FFR could keep gold prices volatile in the short term. Nevertheless, we still expect the Fed to pause and for yields to trend lower towards year-end, which should support gold prices in H2 2023. We see last year’s monetary tightening starting to show up in slowing economic growth later this year. This could have a dual impact: slowing economic growth could trigger monetary policy easing, and gold could attract haven flows.

On balance, we see the gold price holding aboveUSD1,800/oz in the short term. Any dips below this should be short lived, as opportunistic buying would likely emerge. As the macro backdrop becomes more supportive later in the year, we see the price trending higher. We have lifted our quarterly forecasts, targeting USD2,000/oz towards year-end.

Investment demand to increase

Investor’s strategic allocations of gold have been low so far this year. They continued liquidating ETF holdings (-52t of gold) for the tenth consecutive month(Figure 4). Most of the outflows (34t) occurred in February, amid renewed USD strength and rising yields.

The outflows from North America to Europe over the past few months have been linked to hawkish central bank comments. February recorded 25t of outflows in Europe. North America experienced net inflows in December and January before reversing to 10t of outflows last month. This coincided with long liquidation in gold’s speculative position, falling from 16moz to 10.5moz for the week ending 14 February.

Nevertheless, shifting monetary policy and increasing prospects of slowing economic growth should attract more buying. The recent price correction should provide an opportunity for investors to increase their allocations. We expect ETF flows to reverse to +120t this year, with upside bias based on macroeconomic developments.

Speculative net-long positions are at a multi-year low (Figure 5), limiting room for material liquidation. We believe there is more scope for building fresh long positions.

Bar and coin demand is also likely to be supportive, but the growth is likely to slow from last year.

China: demand looks resilient

China’s reopening and improving consumer sentiment is boding well for gold consumption. Physical demand looks robust with spot premium rising in February and currently near USD25/oz. Foot fall in retail jewellery shops is increasing, while jewellery stocks with retailers have depleted. According to the China Gold Association, gold physical offtake increased 18%y/y during two weeks after the Lunar New Year holiday. Imports have been strong since July 2022, with total imports rising to a multi-year high of 1,363t in 2022. While gold shipments via Hong Kong have retreated from their December level to 22tin January, numbers remain healthy.

Trading activity at the Shanghai Gold Exchange (SGE) suggests strong underlying demand. Gold withdrawals increased to 307tin February from 139t in January and 277t in February 2022. A strong spot premium should pave the way for more imports.

India: lower price coincides with wedding demand

India’s gold spot discount briefly flipped to premium due to the improving physical offtake. Falling gold prices incentivised more wedding related purchases last month. We believe restocking may have picked up from February, after the latest Union Budget left gold’s import duty unchanged. Imports in January dropped to 11t, a 71%y/y decline. Having said that, we remain cautious on domestic demand strength amid an increasing probability of below average monsoon rains this year. Rural incomes are down, and a low monsoon rainfall could be a downside risk for gold demand this year. The World Gold Council still estimates 800-850t of gold demand this year.

Silver: price action diverges from fundamentals

The silver price has plunged 16% so far this year, driven in part by the fall in the gold price. Normally, silver outperforms gold in a rising price environment, suggesting silver should do well in the later part of the year.

From a supply-demand perspective, the market is expected to remain undersupplied for this year. Mine supply looks constrained at 2%y/y amid worsening political unrest in Peru, while expansion in silver projects looks limited in other major producing countries. China’s reopening and demand from the solar and electronic sector should support industrial demand (580koz+5%y/y). Indian silver demand is coming off extraordinarily high levels last year, but this should be offset by industrial and investment demand.

PGM: set to outperform

PGM fundamentals are looking constructive. Power shortages in South Africa will limit they recovery from last year’s production losses to less than 1%y/y in 2023.South Africa accounts for 75% of platinum production. Sanctions against Russia also add to supply risks, particularly for palladium.

Improving auto sector growth, higher loadings and substitution away from palladium are likely to benefit platinum. Auto catalyst demand is likely to grow by 5%y/y to 2767koz this year. Constrained supply and robust demand could shift the market into deficit by 145koz. A tighter market should encourage stronger investor activity. We expect ETF holdings to rise by 300koz this year after two consecutive years of outflows. This should push platinum prices to USD1,250/oz towards the end of this year. However, we hold a long-term negative view on palladium due to weakening auto catalyst demand.

Technical

Cautious on false breakout

The gold price rebounded from a double bottom support at USD1812/oz. Price broke the key resistance of USD1845/oz following rise in US unemployment number and collapse of Silicon Valley Bank on Friday. This suggests that bullish momentum is likely to continue, however, one should be cautious of a false breakout. To continue the bullish momentum, gold needs to trade above USD1850/oz level. The next resistance is at USD1960/oz.

On the downside, if price come back below USD1845/oz range, then a consolidation looks possible until it breaks the key support of USD1810/oz, which also coincides with the 100-day moving average. A break of this could trigger a technical selloff, dragging prices to a low of USD1,750/oz. We see this level setting the lower bound for this year’s price range.

Daniel Hynes and Soni Kumari are commodity strategists at ANZ. This article is a re-post from ANZ and is here with permission.

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