Uncertainty is what gold loves — something that is hard to find in today’s world.
After two years of pandemic-driven global supply chain disruptions and border lockdowns, few thought 2022 would bring more shocks than the previous year.
However, the geopolitical turmoil caused by Russia’s invasion and subsequent energy crisis made 2022 more volatile. Gold prices surged to an all-time high of $2,000 per troy inch in March as investors purchased gold as a safe haven investment.
This was exactly what the gold bugs could have predicted. The bullion market isn’t so easy. As the year progressed, the yellow metal lost its luster as higher interest rates aimed at combating inflation drove institutional investors to sell gold because the higher yields on government debts became too tempting to ignore.
After the US Federal Reserve raising interest rates from close to zero to a range between 4.25 and 4.5 percent, gold now trades at around $1,780 per troy-ounce. This includes this week’s hike. Rates have been increasing at the Bank of England, European Central Bank and Bank of England. Despite this, the yellow metal is still above its September low at $1,600, and the average 2010 price of $1,350.
Christopher Louney, RBC’s commodity strategist, describes this as the “long-running tugof war” between negative financial influences that lower gold prices and the metal’s attraction to be a store value in times of inflationary or risky.
However, 2022 is nearing its end. Investors, as well as retail savers need to be aware of what’s next.
Pivot or no pivot?
The 2023 gold bulls and bears will be analyzing a wide range of factors, from record central bank bullion sales to China’s economic opening and geopolitical risk, such as the Ukraine war and the US-China conflict over Taiwan and tensions throughout the Middle East.
The most controversial topic is the interaction between inflation and central bank intervention.
The Fed rate policy and US real yields have the biggest impact on gold prices. It all comes down to the opportunity cost of holding precious metals,” says Bernard Dahdah (a senior commodities analyst at Natixis), a French investment bank. “The big question is, ‘is there a Fed pivot?'”
Investors sell US Treasuries debt in other currencies to make more money from higher yields on US government bonds. This has led to gold trading in an opposite direction to the greenback.
Close Brothers Asset Management managing director Giles Parkinson says, “It’s one thing to have gold when interest rates go to zero. It’s quite another to have them at 4 percent.”
Investors are now evaluating the impact of this week’s rate hike. Even though the Fed raised rates by 0.5 percentage points after a series 0.75 percentage point increases, gold prices plummeted after Jay Powell, chair of the Fed, warned that he couldn’t guarantee that the Fed would not revise upwards its forecast for peak interest rates.
The consensus is that the US central bank will begin cutting rates in 2023’s second half. Paul Wong, Sprott’s market strategist, a specialist in precious metals asset management, said that gold is attractive as a safe haven because of the possibility of financial instability and rate hikes.
After the US inflation report that was better than expected, the Fed signaled a slowdown in interest rates. On Tuesday, the US consumer price Index fell to 7.1 percent. This is lower than the 7.3% economists predicted. Gold jumped above $1,800 due to expectations that the US central banks could tighten the economy to control inflation.
These shifts made precious metals the most successful asset group in November, compared to equities and US dollars, according to Wong’s calculations.
One piece of evidence that supports the opposite view that the Fed will continue to fight inflation is the fact that the gap between short- and long-term US borrowing cost has reached its largest point for just over 40 years.
The two-year Treasury yield was at 4.2 percent, while the 10-year yield was at 3.4 percent. This brings the difference between them to 0.84 percentage points. This pattern, also known as an “inversion” of yield curves, has been present in every US economic downturn for the past 50 years.
Giovanni Staunovo is a UBS commodity analyst, which is the largest wealth manager in the world. He says it’s too soon to call for a Fed pivot and that it’s not the right time to buy gold. He added that he believes in 2023, there will be a time when it will be interesting to purchase gold if the market begins to sense that the Fed is going to lower interest rates.
Inflation persistent and a debt crisis
The fears that markets could be worse than the Fed’s expectations are highlighted by Gold bugs. According to the World Gold Council, an industry group, gold has shown its value in economic downturns before, with positive returns in five of the seven most recent recessions, including the 2008 global financial crisis, and the 2020 Covid shock.
The argument of the gold bugs is that central banks could be forced to reverse their monetary policies due to large amounts of global debt.
According to the IMF, worldwide debt is now at 247 percent of gross domestic product, a much higher ratio than it was before 2007. Pandemic spending can be borrowed on top of the debts that were incurred in the aftermath of the global financial crisis.
Many debts are denominated US dollars. This strength has made these loans more attractive for borrowers in other currencies. However, servicing these loans has become more expensive due to rising interest rates.
Yamana Gold chair Peter Marrone says central banks can’t keep raising interest rates to meet the debt burden of poorer countries. This is something that the World Bank has reiterated.
Marrone explains, “What happens to all that debt when the dollar goes up, local currencies devalue and interest rates go up?” It becomes impossible to keep that up and central banks will eventually have to recognize that.
Marrone warns that we are at high risk of reverting to 1970s-style “dramatic inflation” as pricing pressures are driven by systemic problems such as under-investment and labour shortages. This is something that monetary policy can’t solve.
Marrone says that the 1980 gold price record was achieved when it reached $800 per troy-ounce. The dollar’s current value would bring the price to close to $2700 per troy-ounce. He argues that this leaves plenty of room for gold prices to rise in the future.
Robert Crayfourd (manager of the CQS Natural Resources Growth & Income Fund) offers a more balanced view. He believes there is “real potential for things falling over”. We think gold is a relatively inexpensive insurance.
While some fund managers recognize the potential short-term benefits of adding gold into portfolios in anticipation of a Fed pivotal, others see less of a long term role for the yellow-colored metal.
It is facing a “generational headwind” because it is not well understood by western investors who are more interested in crypto and also because it has no role in the green transformation, according to Nicky Shiels (head of metals strategy at MKS PAMP), a precious metals group.
It does not generate income, at a moment when big investors have more income-generating portfolio assets than ever.
Close Brothers’ Parkinson says that gold doesn’t have any yield. He also said that many equities have strong earnings prospects, even in times of recession.
If high inflation is reversed and the US and Europe experience solid economic recovery, this argument will be even stronger. According to Natixis’ Dahdah, such an environment is “more bullish for equity than gold”.
John Reade (WGC chief market strategist), says that bullion could be affected by China’s successful post-Covid economic recovery. A pick-up in inflation could be a negative for gold, as the Fed may tighten faster. This could be due to a China reopening.
Pillars for price support
The gold bulls also have other powerful weapons in their arsenal. The record-breaking central bank purchases have been a key support for gold. According to the WGC, almost 400 tonnes gold was purchased by central banks in the third quarter. This is the largest purchase of gold since 2000, when quarterly records were established. The first nine months of 2022 saw a record number of central bank bullion sales, exceeding any year since 1967.
According to Gold executives, Russia and China were involved in the purchase of gold as they sought to diversify their holdings following the freezing by western allies of $300 billion of Russia’s foreign currencies reserves.
This was partly confirmed by the People’s Bank of China reporting a 32-tonne increase in its gold holdings in China in November. It was the first increase in three years.
Retail investors have also joined the central bank buying frenzy by wanting to buy gold.
According to WGC data, they have bought bars and coins in fear that inflation might be more persistent than professionals money managers believe. They are more concerned about geopolitical risks such as the Ukraine war and rising tensions over Taiwan.
According to BestBrokers analyst Alan Goldberg, “US retail investors seem steadfastly to believe that gold bars and coins investments offer protection during periods of stubbornly high inflation or economic uncertainty.”
In the third quarter, jewellery purchases by Indian and Chinese consumers returned to pre-Covid levels. Bar and coin demand grew 36% year-on-year.
Gold may also benefit from the cryptocurrency crisis that has erupted following the collapse of the FTX exchange. Louney, RBC says that gold is the only non-debasable asset left in the last resort with cryptocurrencies in the midst of their decline.
However, retail investors and central banks are not the entire market. The bull arguments have not convinced the largest financial investors, institutions, until now.
For seven consecutive months, institutional investors have dominated gold-backed exchange traded funds and they have seen outflows. Fund managers believe that the exodus of gold ETFs could accelerate towards the end of this year, as portfolios are reviewed and the opportunity cost to hold gold becomes more apparent. Parkinson said that investors will still be able to have a lump of Gold if they buy lots of gold and then open the box after 10 years.
The bulls respond that it is all fine when the economic outlook remains stable. It’s not. Shaun Usmar is the chief executive of Triple Flag Precious Metals. A metals financing company.
He might be correct. But 2022 proved that investors can handle even the most severe shocks. They shouldn’t be surprised by 2023’s surprises.
How do you buy gold?
As a retail investor, there are three main avenues to get exposure to the gold market: bars and coins; gold-backed exchange traded funds; and gold mining equities.
Bars and coins are a way to have a bit of metal that you can keep at home. They come in sizes ranging from one-tenth to one kilo, or more. However, the downside is that you will need to pay premiums over spot gold prices to purchase bars and coins. This means there can be a significant transaction cost after you have sold the gold back.
The two main types of gold-backed ETFs are high- and low-cost. These products save the buyer the hassle of having to take physical custody. These products are more liquid and have lower transaction costs, but they can be used by fund managers to move hundreds of millions of dollars at once. Retail investors will find the newer generation ETFs, such as Invesco’s Physical Gold ETF and BlackRock’s iShares Gold Trust, more suitable. They have lower management fees and offer less liquidity.
Another option is to invest in gold mining company equity to get exposure to the prices of the yellow material. These can be accompanied by unexpected outcomes, both positive and negative. The share price can rise sharply if new discoveries are made. However, if technical or political problems arise, shares could tank regardless of gold price. All three of the world’s biggest gold mining companies, Newmont Mining, Barrick Gold, and Agnico Eagle Mines are dual-listed on both the New York Stock Exchange and Toronto Stock Exchanges. Diversifying risks can be achieved by investing in gold mining equity funds, such as VanEck Vectors Gold Miner ETF.
Another set of equities you should consider is precious metals streaming companies. They take small cut on the sales of many projects in exchange for financing. This means that each company or project’s risks are diluted within a larger portfolio. Canada’s Franco-Nevada Precious Metals and Wheaton Precious Metals are two of the most prominent precious metals streaming companies.