What’s the outlook for gold if inflation persists?
As interest rates peak, and recession looms, gold is expected to keep shining this year. We look at what’s next for gold prices and gold equities, and why demand will likely remain high.
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We think prices could remain high for the rest of 2023 and believe fresh record highs for gold are very possible. This could have significant implications for gold equities, which are typically valued using a lower long term price, usually closer to $1,650/1,700Oz. As the market becomes for comfortable that gold prices could be higher for longer, equities have significant room to re-rate.
Why do we think so? If a US recession is on its way, central banks might be forced to loosen monetary policy earlier than they would in previous cycles and before core inflation is truly brought under control. That could mean inflation becomes more entrenched structurally. From our perspective, real interest rates will come down, which should be positive for gold.
But in today’s macro context, we think the key argument for gold should revolve more around the broad ‘normalisation’ of monetary policy, rather than a very specific gold price relationship to interest rates, or the US dollar.
If you believe the Federal Reserve can engineer a true normalisation of monetary policy then that's not a particularly rosy outlook for gold. By normalisation what we really mean is a return to a world where normal business cycles are just regulated by monetary policy and there is no need for central banks to resort to quantitative easing or for governments to employ aggressive fiscal policy to support growth.
That seems highly unlikely to us. There are many macro pressures facing policymakers but the current state of US fiscal affairs, and very elevated levels of debt stand out. It could be that these pressures mean a “normal” policy response to the next downturn is simply not enough and they are forced to head back towards unconventional responses, (either direct monetisation of debt, the resumption of quantitative easing, direct fiscal programmes). That is an environment that is potentially much more positive for gold.
Through this view, gold is to some extent a barometer of the credibility of those institutions. The lower the credibility of the Federal Reserve goes, and the more extreme the policy responses become from monetary and fiscal policymakers, the stronger the case for gold grows against that.
It is becoming apparent that the expansion of central bank balance sheets, particularly the Federal Reserve, is not a temporary measure. Looking back at 2008, Ben Bernanke made it absolutely explicit that QE and the expansion of the banks’ balance sheet was a temporary measure and would be normalised. Some $9 trillion later how temporary do we really think it is now? What do we think would happen to that balance sheet in the event of another downturn? What just happened to the balance sheet in May in response to a regional banking crisis? It went straight back up again.
There are underlying systemic stresses here that really make some of these short term issues a complete sideshow, the debt ceiling being the most obvious one recently.
To sum up, if we're going back to a normalised monetary policy regime, then don't worry about gold. If you're slightly more sceptical, like we are, then gold definitely has a place, as does the broader commodity complex.
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