Monthly gold update

Gold: Spotlight on December’s performance

The gold price added 3.1% in December as the narrative of a potential Fed pivot and weaker USD continued into the month. Gold ended the year at $1,824, which is just 0.3% below where it began the year, having peaked at $2,051 in March and bottoming in September at $1,622.

Gold steadily increased through the month generally driven by real rates expectations and a weakening Dollar. Investors looked to time the Fed’s pivot with its most recent rate hike of 50 basis points (bps) lower than the previous four at 75 bps each. Looking through the inflation data, it’s apparent that although goods and housing-related inflation has been falling, other services remain stubbornly high as does demand in that area. An improvement would be needed in this sector for there to be conviction that the battle against inflation is won and market rate expectations for 2023 will prove to be more accurate than the Fed’s updated dot plot graph.

The change in the macro-economic backdrop has seen an uptick of flows into gold ETFs and the reopening of the Chinese economy is expected to cause an increase in physical demand. Indirectly, the intervention of the Bank of Japan also benefitted gold through the reciprocal weakening of the dollar.

Ending the month at $1,824, the metal recovered six months of losses and was only marginally behind the year’s starting price of $1,829. The rally, continuing from November, saw the Q4 return of 9.8% the best quarterly performance since Q2 2020 when gold hit its all-time high.

Keep an eye on … services (ex-housing) inflation.

Although real yields climbed through the month, they didn’t reach October’s near-term high, falling back at month-end to 1.5%. Economic data has been mixed but, importantly, jobs data continues to be strong and there has been improvement in consumer sentiment as inflationary pressures have fallen. Possibly, real rates should be higher given where we are in the cycle and the high levels of inflation; US Q3 GDP was revised higher, underlining the strength of real potential output.

The Fed was surprisingly hawkish at its December meeting, signalling expectation for the Fed funds rate to remain above 5% into the end of 2023. Markets do not see this as the most likely outcome, as they price inflation falling sharply by mid-year, indicative of a recession. If the Fed was to keep rates as per the current dot plot schedule, the accepted view is this would certainly put the US in recession and, therefore, is not realistic. The Fed does need to be strong in its signalling as it would be very damaging if the Fed was to prematurely call a win on its fight against inflation; financial conditions have been seen to ease recently.

Keep an eye on … services’ demand.

The recovery in the gold price from last month mirrors the fall in the USD index, which fell 2.3% in December. The Dollar was weaker against all major currencies (except CAD) in the month but especially the Yen following the Bank of Japan’s adjustment to the cap on the JGB yield curve. Other central banks are still in hiking mode as the Fed is expected to pause, meaning the USD is losing its relative-yield advantage. Evolving recession concerns are another negative for the Dollar outlook, which would be a further positive for gold; however, renewed geopolitical concerns or worries around China’s reopening are the most obvious factors that could provide some near-term support for the Dollar.

Keep an eye on … US recession probabilities.