Gold's Continued Rally Hinges on Fed Policy, U.S. Dollar
The price of gold has risen by over $300 per ounce since hitting its recent low in November 2022. Even so, gold prices are only back to where they were last April. More broadly, gold prices have been range-bound since the summer of 2020. For the past two and a half years, gold has been unable to break past $2,080 to the upside; and even after its recent rally, it’s still about $140 short of that level (Figure 1). So, can the gold rally continue? Could the precious metal break through to new highs in 2023?
Figure 1: Gold has been range-bound since summer 2020
In some ways, gold’s range-bound performance has been surprising. One might have believed that gold, touted as an inflation hedge, would have rallied as inflation surged. Instead, as inflation ramped up from 1.3% in 2020 to above 9% by mid-2022, gold prices went sideways. Even so, saying gold no longer serves as an inflation hedge might be imprudent. Between the spring of 2019 and the summer of 2020, gold prices rallied by nearly 60% as the Federal Reserve (Fed) began easing monetary policy, slowly at first, and then in grand fashion in March 2020 by cutting rates to zero and embarking on what would become a $4.9 trillion quantitative easing program. Rather than failing to be a hedge against inflation, it might be more accurate to say that investors in gold anticipated the high rates of inflation that came about in the two years after its rally ended.
The actual rise of inflation in 2021 and 2022 posed a problem for gold investors. On the one hand, higher inflation means that the dollar and other fiat currencies will be able to buy less of real assets such as precious metals. On the other hand, once central banks came around to the idea that the surge in inflation was not transitory, they began tightening monetary policy at the most rapid pace since 1981.
Higher interest rates are anathema to gold. As a central bank reserve asset, gold is still a sort of de facto global currency, but one that does not pay interest. As the Fed and other central banks began to raise interest rates and reduce the size of their balance sheets, fiat currencies such as the U.S. dollar (USD) appeared relatively more attractive compared to gold despite higher rates of inflation.
Indeed, gold has shown a consistent negative correlation with the day-to-day changes in the expectations for where the Fed’s policy rate might be in two years as priced by the Fed funds rate (Figure 2). Visually, the correlation is apparent. As markets came to expect lower Fed funds rates in 2019 and early 2020, gold prices soared. Then, in late 2020 and 2021, the market concluded that the Fed couldn’t (or wouldn’t) follow Europe and Japan into negative rates and gold stopped rallying. Finally, in 2022, as expectations shifted towards the fastest pace of Fed rate hikes in more than four decades, gold prices fell for the first nine months of the year (Figure 3).
Figure 2: Gold has a consistent negative correlation with expectations for Fed policy rates
