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Gold rallies on slowing CPI data. The past week (ended 11 November) was a significant milestone for bullion as it recorded its best weekly performance (+5.3%) since March 2020, and an impressive +8.9% gain from recent lows in November. This rally was driven primarily by cooler-than-expected US CPI data for the month of November (actual: +0.4% m/m, consensus: +0.6%; actual: +7.7% y/y, consensus: +7.9%), which raised hopes of slower rate hikes moving forward and provided a brief respite from dollar strength (the DXY index ceded 4.1% for the week). This puts gold’s YTD performance at -3.0% and firmly establishes it as one of the top-performing asset classes for the year thus far.
A victim of positive real rates. Notwithstanding the strong relative performance of gold this year, there are undeniable headwinds facing bullion, chief among which are positive real rates. As can be seen in Figure 2, the 1Y real interest rate has nudged its way into positive territory since June 2020 while the 10Y real interest rate sits almost at 2.0%. This has a significant impact on the attractiveness of gold since the latter is a non-interest-bearing asset. As we wade deeper into a new regime of higher interest rates and inflation rolls over, this dichotomy between interest-bearing and static assets will become increasingly important in determining how investors allocate their capital.
Glimmer(s) of hope. Positive real rates and dollar headwinds are big challenges for gold, but there are some bright spots for its nearer term outlook. While the timing of a Fed pivot remains uncertain, there are indications that the pace of rate hikes may slow. This should weaken the dollar and provide some reprieve for gold, which is often seen as an alternative currency to the greenback. Geopolitical uncertainty is another potential tailwind for the safe haven asset; political turmoil in the UK (which saw multiple key appointment holder changes), continued ambiguity surrounding China’s zero-Covid policy, and the persistence of conflict in Eastern Europe, could all potentially provide a short-term catalyst for gold. Central bank buying has also kept gold prices buoyant – global purchases in 3Q amounted to almost 400 tonnes, the single largest quarter of demand from this sector since 2000 and more than a 300% increase on a y/y basis.
Figure 1: Gold price vs DXY: YTD 2022
Source: Bloomberg, DBS
Figure 2: Real interest rates are turning positive
Source: Federal Reserve Bank of Cleveland, DBS
What does the future hold for gold? The superlative rally in November driven by slowing inflation suggests that investors are primarily concerned with one thing in the short-to-medium term, and that is the Fed pivot. With inflation data trending in the right direction, a turning point (whether a pause or full-on pivot) is on the horizon in 2023. This would see the dollar normalise and catalyse a positive re-rating for gold. But beyond the pivot, the backdrop of positive real rates does warrant a re-assessment of gold’s near-term attractiveness from a return perspective. Nonetheless, we remain constructive on gold as a portfolio risk diversifier given its low correlation with equities and bonds. Investors can gain exposure to gold via the following expressions: i) physical gold; ii) gold futures; iii) ETFs and managed funds on physical gold and gold mining equities; or iv) direct holdings in gold mining equities, which are essentially a leveraged expression of gold.
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