Source: UBS CIO Daily Updates
by Chief Investment Office08 Jun 20233 min read
Thought of the day
The price of gold has remained under pressure following the stronger US employment report supporting expectations that the Federal Reserve will “skip” rather than ending hikes at its policy meeting next week. The potential for higher rates over coming months, after evidence of stubbornly high inflation, raises the opportunity cost of holding the precious metal, which generally doesn’t provide a yield. In addition, sentiment on gold was also undermined by International Monetary Fund data showing official gold reserves declined by 71 metric tons in April, which was the first net decrease in over a year.
As a result, gold has now fallen more than 5% from its recent peak in early May, when investors were more confident that the Fed had already finished its rate-hiking cycle. In our view, a further slide in gold to around USD 1,870 an ounce is possible (from USD 1,945 at present), as markets push back expectations for the start of rate cuts from the Fed.
But we still see potential gains for gold over the coming year, and we view the precious metal as a valuable hedge in portfolios.
Fed policy and the prospect of dollar weakness still supports gold. While the Fed is on a more hawkish trajectory than had been thought in early May, an imminent end to rate hikes still looks likely. In addition, the Fed is closer to starting a cutting cycle than its peers, including the European Central Bank (ECB). We also expect the Bank of Japan (BoJ) to back away from its ultra-easy monetary policy stance, relaxing its targets for government bond yields. This combination can be expected to weaken the US dollar, making gold less expensive for investors holding other currencies. Gold has historically performed well when the US dollar softens due to their strong negative correlation, and we see another round of dollar weakness over the next 6–12 months.
Central bank demand for gold should remain healthy, despite the recent decline. The decline in official holdings reported by the IMF does not reflect a reduction in enthusiasm for gold among central bankers, in our view. The Turkish central bank was reported as the major seller, but the World Gold Council believes these sales were due to local dynamics rather than a change in the central bank’s long-term strategy.
The longer-term trend suggests no reduction in appetite for gold among central bankers. Last year marked the 13th consecutive year of net gold purchases by global central banks and the highest level of annual demand on record dating back to 1950. At 1,078 metric tons in 2022, central banks’ buying of gold more than doubled from 450 metric tons in 2021. Based on the 1Q23 data from the World Gold Council, central banks are on track to buy around 700 metric tons of gold this year, much higher than the average since 2010 of below 500 metric tons.
Geopolitical and economic uncertainty could boost demand for gold among both investors and central banks. Gold has long benefited from safe-haven inflows during periods of geopolitical strife. The intensifying rivalry between the US and China, along with tensions arising from Russia’s invasion of Ukraine, make further flare-ups more likely. In addition, gold’s relative performance versus the S&P 500 improves significantly during US recessions, based on data since the 1980s. While recent US economic data have been resilient, stubbornly high inflation raises the risk that the Fed will overshoot in tightening rates—especially if regional banks continue to cut back lending to ensure liquidity following recent deposit outflows.
So, we continue to see upside in gold over the coming year. We keep our forecast of USD 2,100/oz by year-end and USD 2,250/oz by mid-2024 unchanged.
