What Next for Gold?

Interest rates typically have an inverse relationship to the gold price. With rates remaining high, and in some cases still rising, bonds and fixed income investments are an attractive alternative to gold. But an end to the current rate hiking cycle could positively impact the gold price.

In July, the Federal Reserve resumed raising interest rates and Chair Jerome Powell left open the possibility of further rate hikes, depending on economic data which would be assessed meeting by meeting. Following the announcement, the market was placing the highest probability on rates remaining unchanged for the rest of the year.

The Fed faces a tough balancing act, needing to bring down inflation on the one hand, but manage the impact of high interest rates on the economy on the other. While the threat of a recession appears to be receding, the Fed may still need to rapidly reverse monetary policy down the road to support growth.

The last time the Fed changed course in this way was in May 2019, when it marked the start of the last gold bull run. Investors turned to gold in the face of lower fixed interest yields and a weaker U.S. dollar. The same thing could happen again if recent rate increases need to be rapidly reversed to support the economy due to deteriorating consumer and business confidence.

On the demand side, 2022 was the strongest year for gold consumption for more than a decade, according to the World Gold Council. Consumption of the yellow metal rose 18% to 4,741 tons, driven by a 10% rise in purchases by investors as well as strong purchases by central banks as they bought gold to promote stability.

But this trend reversed in 2023, with demand for gold during the first quarter falling by 13% year-on-year. Ongoing purchases by central banks and a jump in buying by Chinese consumers following the lifting of Covid restrictions were not enough to offset lower investor demand and weakness in India, where the high gold price dampened consumers’ appetite for the yellow metal.

The use of gold in technology also continued its downward trend. Global economic headwinds hurt consumers’ appetite for electronic goods, causing gold consumption in this sector to drop to its second lowest level for a quarter since the World Gold Council started its data series in 2000. At the same time, jewelry consumption was flat.

Meanwhile, the total supply of gold rose slightly during the first quarter to 1,174 tons, on the back of a 2% rise in mine production and a 5% rise in recycling on the back of higher gold prices.

Looking ahead, the outlook for gold is finely balanced. The price has risen by 5.4% in the first half of the year. An end to the Fed’s rate tightening cycle, and a correspondingly weaker U.S. dollar, could provide support for gold. An economic downturn would also push the price higher due to its impact on investors’ appetite for risk. But if the U.S. and global economies continue to show resilience, interest rates are further increased, or the U.S. avoids a recession, then the gold price could suffer.

Correlation between gold and the U.S. equity market is another relationship to watch. Long term correlation tends to be positive.  However, the two can decouple during periods of heightened stress and volatility. This year, we have seen gold and equities react in similar directions to changes in dollar strength and yields. However, we did see gold outperform during the onset of the U.S. banking crisis in March as its safe haven appeal came to the fore.  

With much uncertainty surrounding the gold market, managing the risk of price fluctuations is critical for investors.  With that in mind, more market participants have turned to Micro Gold futures. Trading volume in micros rose 68% in Q2 over the same period a year earlier. Trading in weekly options on gold futures is another tool increasing in popularity, with volume rising 32% in Q2. 

These trends suggest that market participants are watching the market for any sudden reactions to the many fundamental factors affecting gold – from U.S. dollar strength to the interest rates environment. Gold prices face a number of possible scenarios, making gold futures a market to watch closely for the remainder of 2023.