Gold: Entering a new bull market?

Gold has been range bound since mid 2020, having failed to break out to an all-time high in early 2022 or 2023, indicating, from a technical standpoint there is strong resistance at this level as the chart below highlights. The gold bulls would have you believe we are undergoing a ‘consolidation’ phase before a final push to fresh highs for the yellow metal. 

Figure 1: Gold

Source: Bloomberg, data to 07.08.23

In the short term, movements in gold are heavily influenced by moves in the USD and government bond yields, with falling USD and lower government bond yields and more specifically lower real yields, generally seen as a positive environment for gold. With regards the broader USD index, it would appear that this peaked in September 2022 and has been in a downtrend since, with notable counter trend rallies. The USD broke below the all important psychological 100 mark in July, which we believe may result in a significant move lower.  

Figure 2: USD Index (DXY)

Source: Factset, data to 07.08.23

This move lower in the USD index appears notable in the context of the accelerating geopolitical, financial and economic developments such as the below:

1. The desire by many nations to weaken the role of the USD in global trade and commerce;
2. The continuing accumulation of gold by global central banks;
3. The sharply higher US fiscal deficits that will require much-greater issuance of US government bonds,
4. The US banking crisis and signs of credit strains and stalling consumer and business confidence;
5. Evidence suggesting the US economy could be headed into a recession, which will further increase US fiscal deficits and require even greater issuance of US government bonds.

With regards the US government bond market, the yield curve remains inverted by a significant margin, indicating short rates (2 years UST’s) yield more then long term US treasuries (10 yr) in the chart below.

Figure 3: US Yield Curve

 Source: Factset, data to 07.08.23

If we expect the yield curve to steepen and thus the inversion to reduce then one might expect gold to perform well. If this is combined with USD weakness, these two technical factors may become a significant tailwind for the gold price.  

Looking at history is also useful in the context of moves in the gold price in relation to the yield curve. The March 2001 un-inversion of the yield curve marked a major bottom in gold. The mid-2007 yield curve un-inversion accompanied a key breakout in gold from the year-plus consolidation. The June 2019 breakout in gold from the almost 6-year base led the yield curve un-inversion by several months. All these breakouts were followed by a sustained uptrend in gold prices.

These technical factors are shorter term potential gold price drivers. What about the longer-term fundamental backdrop?  As the chart below highlights, reported central bank buying of gold last year was the highest in over 70 years. The unreported number is likely to be far higher. At the same time, foreign purchases of US government bonds since 2013—when the PBOC announced it is “no longer in China’s interests to accumulate FX reserves”—has declined.

Figure 4: Net central bank demand since 1950*

*Data to 31 December 2022. Net demand (i.e. gross purchases less gross sales) by central banks and other official sector institutions, including supra national entities such as the IMF. Swaps and the effects of delta hedging are excluded.

Source: Metals Focus, Refinitiv GFMS, World Gold Council

Central bank buying of gold has continued to be strong during the first half of 2023, and it has been long-rumoured that China holds substantially more gold than the 2,068 metric tons officially reported.

As we highlight in the chart below it is possible we are in the foothills of a major move higher in gold and the start of the 3rd gold cycle. To name a few of the potential drivers:

• The fundamental supply demand dynamic appears tight given the lack of new gold discoveries and falling gold production, plus rising production costs.
• Conservative balance sheet management, thus lower CAPEX plans by major miners
• The macro economic imbalances such as high global government debt levels and inflation at levels last seen in the 1970’s.

This has resulted in increased Central Bank buying of gold, and rumours abound that a possible gold-backed BRICS currency could be announced at the organisation's annual summit in Johannesburg in late August. 

While the US economy appears resilient at this juncture, any slowdown over the second half of 2023 or in early 2024, may result in the Fed being forced into cutting interest rates, resulting in a major upswing in global liquidity, with resultant sizeable monetary inflation that will be further fuelled by the need for Central Banks to plug fast-widening holes in government finances. Should this occur traditional monetary hedges, like gold, could be important portfolio hedges and may prove the major winners.

Figure 5: The history of gold cycles

Source: Bloomberg, Tavi Costa. Data as at 30.06.23.