As expected, international gold prices have fluctuated in recent months.
Prices have fluctuated around $1,700 an ounce as contradictory factors pushed and pushed the precious metal down. Given the geopolitical and economic uncertainties, investors are concerned about the potential development of gold. Currently, prices are mainly determined by two factors: monetary policy and inflation.
When the markets are down
Consider the possibility of a bear market. In other words, the US Federal Reserve (the Fed) continues to tighten and manages to contain inflation without hurting growth.
August inflation in the United States was 8.3% (you). The figure was above consensus expectations but below the 8.5% recorded in July and the 9.1% recorded in June.
Although inflation has moderated somewhat, it is far from the central bank’s target of 2%. Therefore, high inflation figures would continue to dominate the headlines in the coming months, leaving the Fed with an aggressive tightening window open.
Fed Chairman Jerome Powell said at the Jackson Hole Symposium in August that the Fed would do everything in its power to fight inflation, even if it means jeopardizing growth, threatening the economy in the short term in the form of loss of jobs and negative economic growth.
As expected, the FOMC (Federal Open Market Committee) raised interest rates by 75 basis points in September and announced appropriate increases to keep inflation under control.
Rising interest rates pushed nominal yields higher, with the US 10-year benchmark trading at 4% before falling to 3.7%.
Rising interest rates also caused more volatility in stock markets. However, inflation expectations have fallen after peaking in March. This, in turn, has led to a rise in real yields, with the yield on TIPS (Treasury Inflation-Protected Securities) currently topping 1.5%, which has increased the opportunity cost of carrying gold.
With attractive bond yields, the United States is becoming a preferred investment destination, strengthening the dollar. A stronger dollar makes gold denominated in dollars more expensive. This hurts their demand and drives prices down.
If the economy digests the monetary tightening and the Fed manages to achieve a balance between inflation and growth, the so-called “soft landing”, we could see a downward trend in gold prices as inflation cools without causing too much damage to the economy and investors. invest money in risky assets like stocks.
When the markets are bullish
Scenario 1: The Fed tightens too much, pushing the economy into recession
Since the start of its tightening cycle last March, the Fed has raised interest rates by 300 basis points (bps). Interest rates are expected to end the year with a massive gain of 425 basis points year to date.
Beginning in September, the Fed began accelerating the liquidation of its $9 trillion portfolio at $95 billion per month. This aggressive tightening has started to weigh on the economy. The US economy technically entered a recession, contracting 0.9% (annualized) in the quarter ending June 2022 after contracting 1.6% in the March quarter.
S&P Global’s US Composite PMI (Purchasing Managers’ Index) returned 49.5 in September, the third straight month of decline. The US 10-2 yr bond spread continues to reverse, increasing the likelihood of a recession.
Gold has always done well during recessions as there is a flight of money from risky assets into gold due to risk aversion. Barring a full recession, the US could experience a prolonged period of above-average inflation and below-average growth, which will also support gold prices.
Scenario 2: A slowdown in adjustment or a reversal of the aggressive stance to offset growth and inflation
Despite the Fed’s current aggressiveness, its firm conviction could be tested if economic numbers deteriorate significantly. The latest Fed Fund futures data suggests that investors now expect interest rates to peak in 2023 at 4.5%.
In its July 2022 World Economic Update, the IMF revised global growth estimates to 3.2% in 2022 and 2.9% in 2023, or 0.4% and 0.7% below than expected in April 2022.
An economic slowdown could force the Federal Reserve to cut interest rates or reduce the number of interest rate increases and stop or slow the balance sheet contraction. It would be an axis of current aggressiveness.
If due to the Fed’s prioritization of growth over inflation, price pressures, currently at their highest level in four decades, spiral out of control or take hold, we may see inflation expectations unanchored, which coincides with the fall in nominal yields, would lower the real value yields and drives up gold prices.
In short, gold prices will only fall into bearish territory in an ideal soft landing scenario for the economy.
Realistically, however, this could be very difficult to achieve, as much of the current inflationary pressure stems from supply-side challenges that show no signs of easing and are overstepping the bounds of monetary policy, which limits the ability of the Federal Reserve to curb the contraction in demand.
This makes excessive tightening or premature tightening the most likely scenarios, which, as mentioned above, will be bullish for gold. Therefore, to protect capital from macroeconomic uncertainties and financial market volatility, regardless of the bullish or bearish scenario, it is recommended to invest up to 20% of the investment portfolio in gold.