Despite US 10-year bond yields reaching the highest levels since 2008 and the US Dollar appreciating to a level last seen in 2002, gold has held up relatively well. In fact, our internal forecasts model¹ indicates, under such pressure gold should have declined 21% year-on-year in September 2022, yet in reality, gold only fell 5%. Commodity Futures Trading Commission data released on Friday 28th September revealed that shorts in gold futures rose to the highest level since 2018. We believe that a short-covering rally could send gold higher with the appropriate catalyst.

¹ See Gold: how we value the precious metal

The Federal Reserve (Fed) Chairman Powell’s speech at Jackson Hole didn’t help gold. If there was any expectation of a dovish pivot from the Federal Reserve anytime soon, it was eroded after the symposium. More hawkishness from the Fed means strength for the US dollar and gains in US Treasury yields – neither of which is a welcome sign for gold. Both things continued to materialise last month, and so did the expected impact on gold. But Fed hawkishness at a time when the US is already in a technical recession, and sentiment is largely risk-off in equity markets, should result in greater demand for defensive assets. This has not yet materialised given net outflows from precious metals exchange traded products globally last month and speculative positioning on futures also largely declining. This, to us, suggests that gold’s credentials as a hedge against economic risks are currently underappreciated – something that may get rectified in the coming months.

The main driver for falling gold prices of late is the fact that Treasury yields have risen quite sharply. Gold and Treasuries have a strong relationship. But Treasuries aren't the only thing that drive gold prices. Inflation, dollar depreciation also drive gold prices. Today inflation is very tame, but inflation expectations are rising. With very strong monetary support there is potential for inflation to rise substantially in future years. So many investors maintain a financial hedge against future inflation using gold. But for today with relatively weak inflation gold prices are subdued. But this potentially opens up a good entry point. Turning to currency, we believe that the US dollar is on a structurally weak path, with rising indebtedness. US dollar depreciation has only just started and given the lag in the relationship with indebtedness, this trend could last for several years. So we believe the headwinds in gold could be quite temporary, with gold likely to do better as inflation and dollar depreciation pick up pace.”

Gold ended 2020 with positive momentum in December as continuous weakness in the US dollar supported the precious metal. Gold has, however, retreated at the start of January. US Treasury yields have risen, and dollar weakness has eased slightly on renewed hopes of additional fiscal stimulus in the US now that Democrats have established their control in both houses of the Congress as well as the White House. While a larger fiscal stimulus is expected to provide a lifeline to the US economy, ongoing policy accommodation as inflation rises is expected to be dollar negative. Moreover, while vaccines have given buoyancy to risk assets, there is always the risk of markets realising that the underlying economic reality hasn’t improved as much as the equity market rally. This realisation could potentially be triggered by fourth-quarter economic or corporate earnings data. A combination of these forces could help lift gold prices yet again.

Gold prices fell to around $1776/oz at the end of November – their lowest level since July. Gold has bounced back strongly since then trading around $1956/oz (as of 06 January). Gold’s price behaviour since December resembles its behaviour in March last year when gold bounced back strongly alongside equities. This means that despite the risks faced by economies and markets in the short term due to the spread of the virus, markets appear to be bullish on equities, but investors are possibly mitigating the risks to their portfolios by adding historical safe-haven hedges like gold. This new dynamic of gold rising alongside equities is becoming less puzzling in a world faced with risks but fuelled by highly accommodative monetary policy.

Gold prices shed around 5% in November as positive vaccine news stirred a strong risk-on sentiment in markets. Gold is expected to remain highly relevant and important for investors in the coming year for many reasons: accommodative fiscal and monetary policy in major economies including the US; weakness in the US dollar; rising levels of inflation as the global economy recovers; and the continued prevalence of negative-yielding debt. Physical gold held in exchange traded products (ETPs) globally sold off only slightly in November standing at just under 108m tonnes at the end of the month, compared to a high of 111m tonnes in October, and 83m tonnes at the start of the year. Gold prices have bounced back in December (as of 09 December).

Yesterday (Monday 9th November), news of a potential vaccine for COVID-19 spurred a risk rally across equities and oil while gold and silver experienced sharp declines. Today, oil prices are still trading higher as fears of demand destruction that had held back the oil complex over the past month are subsiding. Gold and silver, on the other hand, are starting to reverse some of their losses. Yesterday’s moves are likely to have been overdone for these metals. On Friday 6th November, it looked like gold was outpacing other defensive assets like US Treasuries, but on Monday 9th November, with the sell-off in gold, gold looked under-priced relative to Treasuries. If Treasuries are the benchmark, gold has further to catch up. We believe silver will inevitably move in gold’s slipstream. We don’t think that the news of the vaccine changes the immediate challenge for central banks and the fiscal institutions. The period of monetary largess is still likely to take form which we believe is gold price positive.

 
If the vaccine is capable of speeding up the process of easing lockdown conditions, we believe it should have a beneficial impact on oil demand. However, we doubt the availability of the vaccine on a mass basis in the immediate future. Therefore, the pressure on the Organisation for Petroleum Exporting Countries (OPEC) to act and continue to tighten supply is still there. Their policy meeting at the end of this month will be a key time to demonstrate this.

With markets heading into risk-off mode again following renewed COVID-19 related lockdowns in Europe and elsewhere, gold’s defensive traits are being tested again. Just like in March 2020, gold’s initial reaction was down as the metal got caught up in investors’ de-risking and facing selling pressure as investors liquidate their holdings to meet margin requirements on other positions. However, gold is already showing signs of an uptick and we believe closely correlated silver will move up in its slipstream.

Despite pulling back from record highs in August, gold is still up around 25% year-to-date as of 26 October. So far this year, investors have turned towards gold as a hedge against economic and financial market uncertainty. With inflation now on the rise, gold’s inflation hedging properties are becoming increasingly relevant. Gold, therefore, not only has a role to play in protecting against downside risks, it is a pertinent tool in an upside – given inflation is a property of an economic upswing.

After rallying to new highs on 6th August 2020 of over US$2070/oz intraday, gold prices have fallen close to 10% by September 28th 2020. Year-to-date, gold is still up over 22% and most importantly it is one of the very few assets posting gains during the worst of the COVID-19 pandemic driven crisis. The recent drawdown of gold comes at a curious time when inflation expectations are rising, the US dollar has been weak and when we haven’t really escaped the economic uncertainty that the COVID-19 pandemic has brought about. The cyclical market drawdowns we have seen in the past month may be placing downward pressure on defensive assets like gold and Treasuries, just as we saw back in March 2020. At that time investors were redeeming liquid assets due to pressure in other parts of their portfolio. If gold is viewed as only a defensive asset, then a cyclical recovery may hurt prices. However, historically gold has not just been a defensive asset. Its price tends to rise with inflation which is generated during periods of stronger economic growth. So long as recovery is not met by an aggressive tightening of monetary policy, gold is likely to do well.