Where are we now?
Firstly, I've got two charts here outlining gold performance since the onset of the pandemic. The first is the outright gold price, and the second is the gold/silver ratio. While this piece focuses on gold, that does not mean I've forgotten about silver, and I am also bullish on this other commodity which has more of a pro cyclicality than gold.
Above, the gold price in USD/oz shows how we are a long way off the highs of the pandemic which were set around USD2100/oz in mid 2020. Now, we are around USD300/oz lower - or around 15%. This has occurred despite the Fed and other central banks maintaining an unprecedented level of monetary stimulus over the last 2 years.
Below, we also have another interesting chart - the gold/silver ratio. This chart I like as it shows the relative prices of the two commodities. As the chart below shows, we have clearly been in an uptrend over 2021, but this is not particularly concerning that we are actually lower than where we were prior to the pandemic.
What about interest rate hikes and a tightening cycle?
To me, this makes some degree of sense, given we are entering a major pro cyclical period where growth is outperforming and industrial metals are likely to perform well. However, going forward as the central banks of the world start to take their foot, of the monetary accelerator, I expect we could see a gradual increase in the gold/silver ratio once again similar to that in the last tightening cycle.
If we take a look at the performance of gold/silver compared to the Fed's balance sheet we can see that it has traditionally risen during the periods of quantitative tightening.
From Bullard's comments yesterday, it seems like balance sheet runoff is more than just something he is considering and an active aim of the Federal Reserve to reduce the size of the balance sheet before the next crisis.
“Asset purchases will come to an end in the months ahead, but the FOMC could also elect to allow passive balance-sheet runoff in order to reduce monetary accommodation at an appropriate pace,”
In the previous period of balance sheet runoff, the above chart shows a gradual grind higher in the gold/silver ratio. Obviously, we only have a sample size of 1 here, and there were likely a number of other drivers behind the change in ratio to do with geopolitical risks, the broader economy etc.
However, when we look at silver we can see that it has actually had a pretty decent run and is well above pre-pandemic levels. Much of the industrial outlook is probably already baked into the price, and from here while I like silver, and do not expect downside, I prefer gold due to its purer interest rate plays.
The problem with rates:
Let's now have a look at market pricing for Fed hikes. This really is where my conviction for gold comes from. There are essentially too possibilities this year.
1) Inflation starts to cool down and the Fed is able to stick more with its longer-term objective of full employment within the economy. I.e. They do not hike as much as expected.
2) The Fed panics about inflation and starts hiking too quickly, leading to a killing off of the global economy, which in turn requires more Fed support. I.e. They hike too quickly and kill the recovery.
In either of these situations, the outlook for gold is pretty solid. The Fed is trying to engineer a situation where they perfectly judge everything and don't disrupt markets while keeping easy financial conditions. At the moment, everything is priced for a Goldilocks Fed hiking cycle.
I needn't elaborate when I say history isn't exactly full of perfect Fed tightening cycles - nearly always we end up either with the economy running too hot or too cold and in recession.
Source: Refinitiv - nearly 100bps priced for 2022!
To me, this is clearly showing that the risk is for the Fed to disappoint the market. In turn, this means that the outlook should be pretty weak for the USD, which in turn will be good for gold. If inflation does start to show signs of easing, then we clearly are in a position where the Fed will exercise patience.
I have outlined lots of my views on the Fed repeatedly, and I don't want to repeat them all in the gory details here, but I am keen to stress the risk is clearly to the downside in this Fed hiking cycle.
Personally, I don't see the first hike until June of this year. All of this should be good for gold.
Price Targets?
Ok fine... I'll put everything on the line and give you a quarterly forecast profile... here goes:
Q1: USD1850/oz
Q2: USD1900/oz
Q3: USD1950/oz
Q4: USD2000/oz.
This is a bullish profile, I'm well aware, but the upside is there for the taking in gold. Let's see where we end up. Of course, I could be completely wrong :)
The Last Line:
Everyone thinks tapering / balance sheet runoff is bad for gold... that's not the case from the last cycle - note when gold exploded higher as balance sheet tapered lower.
In my view, this could well be the case again. Gold is currently priced for the Fed perfectly, but in reality they are likely to make a mistake somewhere this year. Whether this is with excessive hawkishness, or allowing inflation too hot, gold will be a very much more attractive asset by the end of 2022 than at the end of 2021.
Please do disagree in the comments below, or drop me an email at luke18032000@gmail.com
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