Gold to surge 25% as inflation falls

In this week's market update:

• Precious metals continued to rally, with gold prices pushing up toward USD $1900 per troy ounce (oz) overnight, up by 4% for the week.

• Silver was also strong, rising by 2% in USD terms, last trading just below USD $24oz, with the gold to silver ratio (GSR) now sitting at 80.

• Continued weakness in the US dollar index (DXY) has been a major contributor to market movements, with DXY last trading just above 102, down 3% for the week.

• Risk assets have rallied across the board, with commodities (+3%), equities (+5% in the US) and cryptocurrencies (Bitcoin +13%) all rising strongly.

Gold surging, but does it need to pull back?

Precious metal prices have continued their recent surge with gold (+4% over the past five trading days) at one point trading above USD $1900oz overnight, as continued easing in US inflationary pressures raises expectations of a policy pivot from the US Federal Reserve.

The drop in US treasury yields, both nominal and real, as well as the continued weakness in the US dollar have also contributed to the bid we are seeing for gold, with silver also rising, though by a more modest 2% over the past week.

While there are several underlying catalysts supporting the recent surge in gold, and while we remain incredibly optimistic about both the long-term outlook for the precious metal complex, and the role these assets can play in a portfolio (we discuss why in more detail below), a short term pullback and market consolidation would not surprise.

Firstly, gold and silver have rallied by 16% and 25% respectively in USD terms since late October, with those kind of returns more than respectable for a full year, let alone just over two months, which is the time frame its happened in.

We’ve also seen a halving in short positions in the gold futures market (speculative positioning only) since November, with long positioning also increasing. To this we’d add to the fact that silver has so far not been able to push above USD $24oz.

It may well do so, but the fact that price level is acting as something of a ceiling right now, with the gold to silver (GSR) increasing to 80 this week, rather than decreasing as it typically does in fully fledged precious metal bull markets, is another indicator the market may need some time to consolidate recent gains.

This thinking was in essence supported by SaxoBank, who, while noting gold’s strong performance in recent weeks, and the multiple catalysts that will support precious metals this year, have commented on the need for a potential short-term pullback, stating;

From a technical perspective the acceleration today above an already steep uptrend at $1852 has raised the risk of the market having rallied too fast too soon, and potential buyers should consider holding back waiting for a correction or consolidation phase.

As a final point, we have also seen a notable uptick in more bullish commentary about where the gold price is heading, which is often a contrarian indicator.

This includes comments from Credit Suisse who recently opined that we could see gold trade at USD $2,300oz (a circa 25% rally from current levels), though they did offer some short-term targets to the downside to watch out for too.

Will stocks and bonds rally this year?

Given the sharp drawdown in markets that we saw in 2022, there are many investors who both hope and expect this year will be more kind, with these investors positioned to benefit should asset prices rise.

Tables like the one below (sourced here) give some credence to this expectation, with 60/40 portfolios (made up of 60% equities and 40% bonds) rising more often than they fall in the year after major drawdowns, with average returns in the following year of 4.2%.

Look out three, five and seven years, and the numbers look more impressive, with average gains increasing as the time period lengthens, and the “win” rate (ie. how often prices rose vs fell) getting stronger too.

While data like this will no doubt help drive investment decisions this year, there are some limitations to it (as there is with any data). The most notable of those is that it doesn’t factor in inflation, which eats away at the effective value of any nominal asset price gains.

For example, in 1973, 60/40 portfolios fell by 7.1%. They went on to fall another 14.7% in 1974, but by the end of the decade, they were 66.6% higher.

That doesn’t sound so bad, until you consider the fact that consumer prices rose by the better part of 85% over the same time period, with the online Bureau of Labor Statistics Inflation calculator highlighting that $1,000 of December 1973 money had the same purchasing power as $1,867.97 of December 1980 money.

Given that inflationary environment, the 66.6% gain the above table highlights would still represent a person losing wealth in real terms.

Tables like the one above also don’t highlight how much better one would have done had they used alternative assets to protect a portfolio, which obviously includes gold.

For example, in 2001, the gold price rose by 1.4% rather than falling by 4.9% as per the above 60/40 portfolio. In the three, five and seven years that followed, gold rose by 58%, 130% and 212%, dramatically outperforming the recovery in the 60/40 portfolio.

Similar outperformance was seen in the 1970s, with gold up 72% in 1973 (vs -7.1% for 60/40). Seven years later, gold was a further 425% higher.

If we do indeed see a continued move into a Stagflationary environment this year, it wouldn’t surprise to see gold (and silver) lead the market by such magnitude, even if inflation itself lifts nominal prices of most asset classes.

Long-term outlook for bullion is strong

Supporting the notion that gold and other precious will outperform over the next few years is the sheer volume of headwinds that precious metals have had to deal with in the last year, most of which they have shrugged off.

Many of these headwinds were highlighted in this article, and include

• The second most aggressive pace of interest rate hikes by the US Federal Reserve in history

• A rampaging US dollar, which rallied by the better part of 30% in under a year and a half, before its recent pullback.

• The largest gain in the history of the Treasury inflation protected security market, with real yields rising by more than 2.50%

To that we’d add outflows from ETF investors, speculative money flows that at one point late last year turned negative (as in more of that investor subset were betting the gold price would fall, rather than rise), which is a historical anomaly.

Indeed, the developments in this part of gold market were highlighted by SaxoBank in their recent update about gold’s that we highlighted earlier in this report, with ETF and speculative demand one of several catalysts that could support precious metals this year.

To that end, it is almost certain that one of, if not the major factor explaining the recent strength in the gold price is the now very strong expectation that we are heading toward another global recession.

The chart below from TopDown charts, which shows how aggressively rates have been hiked in the past 18 months, gives credence to this, with global policy rates moving from close to 2% on a GDP weighted basis to close to 5% by the end of last year.

The number of rate hikes, and the absence of rate cuts also dwarfed what we saw in the lead up to the Global Financial Crisis, with the higher debt to GDP ratios that we see in the world today only exacerbating the risk that current monetary policy trajectory will end up causing significant financial market and/or economic fallout.

Given that backdrop, investors are all but certain that central banks will pivot to more dovish monetary policy, with the rally in the gold price in essence an indicator that the market smells trouble brewing.

Inside the office this week

Silver coin demand remains at elevated levels in ABC Bullion offices, while 50-gram ABC Bullion Gold Cast Bars are also popular. We are also seeing strong demand for limited series products like the 1oz Prestige Bullion Big Five Gold Elephant Minted Coin, with investors adding these to their holdings.

The 1oz Prestige Bullion Big Five Gold Elephant Minted Coin.

Warm Regards,

Jordan Eliseo
General Manager

ABC Bullion Australia

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