Inflation, rate hikes and Omicron: What’s next for gold?
Gold prices have continued to trade in a narrow range in December, with the precious metal oscillating around the USD 1,800/oz price point.
Assuming there’s no large move in the final trading days of the year, the gold market looks like it will end 2021 almost where it started, with the US dollar down around 4% for the year so far and the Australian dollar up 3%, as shown in the chart below.
As highlighted above, precious metal started 2021 on the back foot, with declines of almost 10% seen in both the Australian and US dollar gold prices.
Since the late March lows, the precious metal has climbed 14% (Australian dollar) and 7% (US dollar), buoyed by rising inflationary concerns, with annualised consumer price increases in the United States rising from below 1.5% at the start of the year to 6.8% by November.
A decline in real bond yields since late March has also supported gold in the past nine months, though it has also faced serious headwinds in the form of:
- a rising US dollar index, which is currently +7% YTD.
- an uptick in global economic output, with OECD forecasts for global economic growth in 2021 rising from 4.2% to 5.7% across the year.
- an incredibly strong rally in equities, with the S&P 500 +23% YTD, complemented by record inflows into risk assets.
Outflows from gold ETFs and a halving of net long positions in the gold futures market have also impacted gold’s performance this year. This has occurred even as consumer demand has not only recovered from the COVID induced hit seen in 2020, but exceeded figures seen in the first three quarters of 2019.
As we head towards 2022, gold looks delicately poised, with a range of factors likely to influence prices next year.
Potential headwinds include the likelihood that US inflation rates will soon decelerate, that we will see at least three interest rate increases (with more to come in 2023), and that the US dollar could continue to push higher.
That said, the fact gold didn’t sell off last week suggests that the accelerated tapering of asset purchases and the more hawkish interest rate projections announced by the US Federal Reserve at its recent FOMC meeting were already priced in.
On the positive side, expensive equity markets and the potential for a correction may see gold find a safe haven bid, especially given the low nominal and negative real yield environment investors face when looking at sovereign debt markets.
With markets already looking jittery given the withdrawal of policy support, it would not take much to boost gold. The emergence of the Omicron variant and the lockdown response we are starting to see, as well as the continued energy crisis in Europe and heightened tensions between Russia and Ukraine, also represent potential tailwinds as we head into the new year.
Gold may also benefit given the likelihood we’ll see economic growth downgraded in the aftermath of the rejection of US President Joe Biden’s US$2 trillion “Build Back Better” plan.
It should also be noted that while rising prices haven’t led gold to deliver a positive return in 2021 so far, we think it’s too early to say the precious metal has ‘failed’ as an inflation hedge, as some have argued this year.
Because, while the Fed recently dropped the use of the word ‘transitory’, the market remains almost completely unconcerned that inflation is here to stay, with five-year break-even inflation rates now sitting at 2.65% while 10-year break-even inflation rates are below 2.40%.
This leaves the market with the largest gap on record (4.4%) between the current annual CPI rate (6.8%) and the 10-year break-even inflation rate, as the chart below highlights. The only other time there has been a gap anywhere near this large was immediately before the Global Financial Crisis hit.
Given this backdrop, there is plenty of room for inflation to fall from current levels yet still overshoot market expectations as we head into 2022.
Finally, it’s worth noting that gold has now worked through a roughly 15-month time period that has seen prices correct by almost 20% from peak to trough.
Sentiment has also turned 180-degrees in this period, from near-unanimous "bullishness" in Q3 2020, to a far more subdued outlook today, with a range of financial institutions releasing bearish gold forecasts in the last month.
Their projections may yet prove accurate, but it is of such things market bottoms are made.
The data above is current as of 17/12/2021 unless stated otherwise.
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Gold bull since early 2000. Have spent +20yrs working in investment analytics, research & portfolio construction. Author of two books on investing in gold and the causes of the GFC. Lover of markets, competition & technology