- This year has seen an increase in the price of gold and real interest rates in the United States.
- Tightening rate cycles are not always bad for gold.
Look no further than bullion to see how a historically unusual confluence of global risks is reverberating through markets.
Prices have risen to their highest level since the beginning of June, owing to escalating tensions between Russia and the West over Ukraine, as well as a surge in US inflation to its highest level in decades. Simultaneously, real interest rates, a key driver of gold, have risen this year, reversing the normally inverse relationship between the two. And, for the time being, Bitcoin is losing the debate over whether it is a better modern-day store of value than bullion.
“Geopolitical risks have manifested and are escalating,” said Nicky Shiels, head of metals strategy at MKS PAMP SA, a precious metals trader and refiner. “Gold at $2,000 is a better bet in the short term than gold at $1,800.” On Wednesday, the metal was trading in the middle of that range.
After Vladimir Putin recognized two self-proclaimed separatist republics in eastern Ukraine as independent, US President Joe Biden announced sanctions this week targeting Russia’s sale of sovereign debt abroad and the country’s elites, a dramatic escalation in the standoff. Biden described the move as the beginning of Russia’s invasion of its neighbor, but Moscow has denied any such plans.
Before demand for a safe haven soared over Ukraine, some observers were perplexed by bullion’s tenacity, especially in light of the Federal Reserve’s impending tightening cycle. One concern was that the Federal Reserve of the United States might risk triggering a recession by raising interest rates more frequently and to a higher level than might be required to keep inflation under control.
“What’s really driving gold is a sense that the Fed’s chances of making a policy mistake are increasing,” said Ross Norman, CEO of Metals Daily, a precious metals information portal. “There’s a sense that the Fed is behind the curve, and when you have to play catch-up, you have to put a fairly aggressive rate-hiking move forward, which a fragile economy may not be well positioned to adjust to.”
According to Peter Berezin, chief global strategist at BCA Research Inc., gold is also benefiting from a drop in demand for cryptocurrencies, which are frequently viewed as an alternative “fiat hedge.” Bullion has increased by more than 3% this year, while Bitcoin has decreased by 16%.
Bullion had a largely disappointing 2021 after surging to an all-time high the previous year on the back of ultra-accommodative monetary policy and pandemic support. Rate hikes are almost certain in March, according to JPMorgan Chase & Co. economists, who predict increases of 25 basis points at nine consecutive meetings. This could have an impact on bullion, which is a non-interesting asset.
“Since the 1970s, gold traders have never lived through a rate-hiking cycle accompanied by high inflation,” said Shiels of MKS PAMP. “There’s a lot of uncertainty about how this will play out: hiking cycles aren’t always bearish for gold, and it all depends on how real rates react.” At the end of the day, gold does not control its own destiny, which adds to the complication.”
Rising global risks have not gone unnoticed by investors, who have piled into exchange-traded funds backed by gold. SPDR Gold Shares holdings had increased by slightly more than 50 tons since a 20-month low in December as of Feb. 18.
Physical demand from China and India, as well as the possibility of undisclosed central bank purchases, are other bullion-supporting factors.
After an abysmal 2020, the world’s largest consumers are back in full force. Shipments to China from Switzerland, Europe’s main refining hub, nearly five folded in January, reaching a five-year high. According to the World Gold Council, India’s imports increased to their highest level in a decade last year, as jewelry sales nearly doubled, with the demand outlook remaining positive.
Meanwhile, according to the council, central banks added 463 tons of gold to reserves last year, an increase of more than 80% from the previous year. Purchases will continue, but at a slower pace. Citigroup Inc. said in a Feb. 17 note that Russia and China’s central banks may look to buy gold on the open market to support prices when real yields rise. “We believe this already occurred in 2022, but it may not have been reported in data,” the bank said.
Still, the question is whether gold can maintain levels around $1,900 per ounce when geopolitical tensions ease. In a note last week, UBS Group AG’s wealth management unit stated that “a break in the negative correlation between gold and US real rates never really endures, and this time is no different.”
Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.