Gold prices soared during the worst days of the health crisis, but have fallen back recently. What are the factors that could push the price in either direction?
- We don’t believe that support for gold prices is no longer there. But, equally, we do think that some of the factors that pushed them higher, such as falling real yields and exceptionally high uncertainty, are no longer there either. The risk skew is now more balanced.
- With real yields likely to stay at rock bottom (but not falling any further), and the US dollar weakness we project, the medium-term outlook for gold is still supportive. But the gold ETF outflows we’ve seen most recently, if protracted, could be a downside risk in the short term.
- We recalibrate our gold price forecast and now expect a modest increase to about 1,900 $/oz at the end of next year, some 100 $/oz lower than our previous forecast. The outlook for 2022 is uncertain. As we expect higher inflation, our forecast of 2,000 $/oz remains although none of this is guaranteed.
- We think about gold as an investment. There are different reasons for holding it in portfolios. Since the beginning of the year, our tactical asset allocation benefited from a significant overweight in gold. But the near-term price upside is more limited from current levels.
- Beyond this tactical view, another key reason to include gold in a portfolio, over more extended horizons, is diversification – as the long-term correlation between global equity and gold returns is close to zero and gold often performs well when other asset classes struggle.
- These unique characteristics make gold valuable in a well-diversified portfolio, regardless of the immediate price outlook.
Typical valuation frameworks don’t apply to gold. Without a coupon or dividend, discounted cash flow models can’t be built. There are no expected earnings or book-to-value ratios either. Conceptually, four drivers explain fluctuations in gold prices. First, periods of economic growth tend to raise gold demand for jewellery, technology and savings. Second, bouts of uncertainty often boost demand for gold as a safe-haven investment, for diversification and hedging. Third, the opportunity cost of holding competing assets is a key determinant. Fourth, capital flows and positioning have an impact too, by amplifying or dampening the momentum in gold prices.
Our statistical models indicate that, based on historical correlations with key drivers, we’re at around ‘fair value’. Real yields are a particularly important driver for our gold outlook, and we see them at low (but not lower) levels for an extended period of time.
Our analysis of past cycles indicates that gold returns would tend to be weaker during the early stages of the cycle, and stronger during the later ones. However, it also highlights that the US dollar weakness we project – along with real yields at rock bottom – are generally associated with rising gold prices, pointing to some upside over the medium term.
Our work on gold supply and demand suggests that, at shorter horizons, gold ETF holdings are a key swing factor. After record inflows, the past few weeks have seen outflows – with some momentum lately – pointing to downside risks.
Putting it all together, we recalibrate our gold price forecast. We now expect a modest increase to about 1,900 $/oz at the end of next year, some 100 $/oz lower than our previous forecast. Our view is that, over the next few months, we may see quite a few oscillations: investment flows may continue to correct for some time; but the all-important drivers of rock-bottom real yields and US dollar weakness should remain quite supportive. More broadly, most fundamental factors are positive for gold, although the majority of them don’t indicate that prices should be higher (or much higher anyway). The outlook for 2022, being so far away, is quite uncertain. On balance, the fundamentals won’t really change, in our view, with one exception: we may see higher inflation the year after next. This is why we confirm our forecast of 2,000 $/oz.
As we think about gold as an investment, there can be different reasons for having it in a portfolio:
- Tactical: The role of gold depends on both the immediate outlook for the precious metal’s price and the investment horizon. Due to the global economic recession and high uncertainty that characterised most of 2020, the gold price rose by more than 20%* since the beginning of the year, and our tactical asset allocation benefited from a significant overweight in gold. As explained above, the near-term price upside is more limited from current levels.
- Strategic: Beyond this tactical view, there’s another important reason to include gold in a portfolio for the long run: diversification. As gold’s drivers are – at least in parts – very different from those of other asset classes, its performance can diverge meaningfully from equities or bonds. Particularly, the long-term correlation between global equity and gold returns is close to zero, making it a strong candidate for diversifying a portfolio. What’s more, gold often performs particularly well in periods when many other asset classes struggle (think about recessions or periods of strongly rising inflation). These unique characteristics make gold a valuable cornerstone of a well-diversified portfolio, irrespective of the immediate price outlook.
*Bloomberg market data.
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Authors
Daniele Antonucci
Chief Economist & Macro Strategist
Carolina Moura-Alves
Group Head of Asset Allocation
Bill Street
Group Chief Investment Officer