Turning macro tides may spur new highs for gold

GOLD’S trajectory in 2023 surprised many investors as the metal remained resilient against traditional macroeconomic headwinds. Market volatility, geopolitical turmoil, and uncertainty across US monetary and fiscal policy all helped push gold higher, and fundamental demand – from record central bank purchases to robust jewellery demand – also helped gold weather a challenging macroeconomic backdrop.

Looking ahead to 2024, investors’ improving perception of gold could result in increased global demand and potential new highs. Overall, the outlook for gold may be buoyed by the turning of three macroeconomic tides:

• Dovish US monetary policy, as US consumer-led economic growth slows and inflation stabilises
• A softening US dollar as the global economy closes the gap to US growth and central bank gold
• Bullish investor sentiment for gold amid heightened risks

Shifting US monetary policy

The biggest surprise for gold in 2023 was its continued resilience in the face of rising US real yields led by slowing inflation and higher nominal yields. The US 10-year Treasury yield exceeded 5 per cent in 2023, its highest level since September 2007.

Based on historical correlations between gold and the US 10-year Treasury yield, gold should have fared much worse than it did over this period. Instead, the gold market was steadied by record central bank gold purchases, increased market volatility, and geopolitical turmoil.

As inflation levels have begun to trend lower, stabilising near long-term historical averages, the Federal Reserve’s impetus to continue hiking interest rates has largely been removed. In fact, market expectations are currently pricing rate cuts during the first half of 2024, a potential boon for gold prices as a shift to a more dovish Fed should support gold’s prospects.

Boost from US dollar headwinds

The US dollar’s outlook in 2024 is also lukewarm. A scenario of interest rate cuts may spur demand for non-dollar currencies as interest rate spreads narrow globally. Additionally, the potential for US government shutdowns, fiscal policy debates, and political stand-offs ahead of the 2024 US election cycle persist.

With a growing debt burden and fiscal deterioration having already led to a credit downgrade for the US this year, the potential for continued uncertainty on the fiscal policy front could create hurdles for the US dollar’s prospects.

Meanwhile, the outlook of slowing growth or even recession could potentially weigh on the US dollar over the medium term. Given the outlook for a flat or weaker US dollar, gold could find support next year.

Moreover, continued gold buying by central banks, led by emerging markets, also may weigh on the US dollar’s prospects as emerging market central banks continue to diversify their reserves away from the US dollar and other reserve currencies. While this is a gradual trend, it’s a strong potential catalyst for gold, especially as emerging market central banks’ share of gold reserve holdings is three times less than that of their developed market peers, on average.

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Investor sentiment on gold

Sentiment among gold investors, particularly exchange-traded fund (ETF) investors, has been lacklustre in recent years. Despite strong demand for physical gold bars and coins, global gold ETF flows in 2023 are on pace for the third consecutive year of net outflows.

Given gold’s price performance over this period, an interesting dislocation between the gold price and gold ETF flows has emerged. This dislocation, wherein gold ETF holdings are liquidated against a neutral gold price environment, is fairly unique in the context of the track record of gold ETFs. This can be partly explained by rising yields attracting yield-chasing investors, alongside tremendous central bank gold purchases in 2022 and 2023 and robust demand among gold consumers for jewellery.

Given gold’s resilience in 2023, if investors do return to the gold market in 2024, this dislocation would narrow and the correlation between the gold spot price and ETF flows would revert to historical levels. This could prove a powerful tailwind, as investor buying synchronises with central bank buying to potentially drive gold prices higher.

2024 gold price scenarios

For 2024, our base case is that we expect gold to potentially trade in a range between US$1,950/oz and US$2,200/oz. Under this scenario, global and US growth slow while avoiding a recession; the US dollar is flat to slightly down in response to a limited number of rate cuts by the Fed; and interest rates remain higher for longer. Consumer demand for gold in emerging markets remains steady, supported by the continued robust gold buying from central banks.

In our bull case, we expect gold to see a potential trading range between US$2,200/oz and US$2,400/oz. Under this scenario, the US experiences an economic recession with significant interest rate cuts by the Fed and a weaker US dollar, while market volatility increases, sparking strong investment demand for gold.

In our bear case, gold potentially trades between US$1,800/oz and US$1,950/oz. Under this scenario, the US and global economies exhibit expansionary growth, and the Fed hikes rates to tamp down rising price and wage inflation from tightening labour markets.

Moreover, lower market volatility reduces investment demand for gold and a resulting stronger US dollar increases the price of gold internationally, albeit emerging market consumer demand for jewellery, bars, and coins remains healthy, supported by rising inflation and weakening currencies.

Adding gold to portfolios in 2024

The possibility of greater equity volatility in 2024 remains elevated, with potential market drawdowns stemming from stretched equity valuations, geopolitical tensions, and commodity volatility. Gold may provide significant portfolio protection as a risk management tool in a heightened risk environment. This was the case in 2023, when gold helped as a buffer against rising market volatility from the US regional banking crisis, the emerging Israel-Hamas war, and the ongoing Russia-Ukraine war.

Against an increasingly uncertain market and economic backdrop, investors may consider an allocation of 5 to 10 per cent in gold as a hedge against the elevated risks ahead. In a falling rate environment, investors typically invest in bonds to diversify equity risks. But gold also helps to diversify bond allocations, particularly during heightened interest rate volatility.

When evaluating monthly changes to US real interest rates, gold has averaged a slightly higher return than US bonds. Given the similar historical performance and gold’s historically low correlation to bonds as well as equities, investors may benefit from gold positions, particularly in anticipation of lower rates in 2024.

The writer is Apac gold strategist, State Street Global Advisors