In its most recent report, the World Gold Council (WGC) discussed gold’s behavior and wondered, “Can gold break away?”
The performance of gold is affected by the combination of its roles as a consumer item and an investment asset. It is fueled not only by investment flows, but also by manufacturing and central bank demand.
To understand its behavior in this setting, we focus on four important drivers: 1: Economic expansion – positive for consumption, 2: Risk and uncertainty – positive for investment, 3: Opportunity cost – negative for investment, 4: Momentum – dependant on pricing and positioning.
In practice, these elements are captured by economic variables such as GDP, inflation, interest rates, the US currency, event risk, and the behavior of competing financial assets, which affect the macroeconomic environment.
A soft landing with a sidewinder! Bonds and riskier assets may gain from a soft landing scenario. Earnings projections appear to be optimistic, and high interest rates would keep bonds appealing. This is consistent with earlier evidence, with both bonds and stocks performing well during the previous two gentle landings. Gold, on the other hand, has performed poorly, gaining somewhat in one direction while declining in the other.
This is most likely due to two competing forces: lower nominal rates and decreased inflation. Lower nominal interest rates should provide some relief for gold; 75-100 basis points of policy rate cuts are anticipated to result in little more than c.40-50 basis points of longer maturity yield declines.
We estimate this response based on previous soft landings’ bull steepening, as well as sustained term premium pressure, quantitative tightening, and significant issuance supply in 2024. All else being equal, the decline in longer maturity yields implies a 4% gain for gold.
Unfortunately, everything else is unlikely to be equal. If inflation falls faster than interest rates, as is widely projected, real interest rates will remain high. Furthermore, weak growth may limit gold consumer demand. In conclusion, predicted policy rate easing may be less favorable to gold than looks on the surface.