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US inflation is falling
Source: WisdomTree, The Federal Reserve Bank of New York. Data from January 1962 to May 2023, with forecasts extending to May 2024. NBER = National Bureau of Economic Research. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
Source: WisdomTree, Bloomberg. January 2015 – May 2023. Historical performance is not an indication of future performance and any investments may go down in value
Gold Outlook to Q2 2024
Recession risk increasing as central banks continue to slam on the brakes
JULY 2023
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Figure 1: US recession probability
With recession risks rising, investors could look to gold as a defensive asset. One measure of recession risk, based on yield curve inversions , indicates a 70% chance that the US economy will be in recession in mid-2024 (Figure 1). The Federal Reserve Bank of New York model has had a fairly good track record of pinning down past recessions, and so it’s hard to ignore this warning sign.
Recession risk rising
US inflation is arguably falling hard. However, the stale shelter data in the Consumer Price Index (CPI) calculation masks the reality. An alternative inflation metric, calculated by WisdomTree (that substitutes real time housing metrics for shelter inflation), reads at 1.4% instead of the 4.1% official Bureau of Labor Statistics (BLS) headline inflation, with core inflation using real time metrics running at 2.1% - almost exactly the Federal Reserve’s (Fed) target inflation. The official BLS reports use a shelter inflation metric which is running at 8% over the last 12 months. However, our alternate metric puts the shelter price increase at 0.5%. This single variable change would dramatically alter the Fed’s inflation narrative and shows the Fed should be done hiking.
However, Fed dot plots indicate that members of the Federal Open Market Committee (FOMC) expect several more rate hikes to come. That could potentially overdo it and raises the risk of recession.
Other developed world central banks appear far from done in their respective hiking cycles. The European Central Bank (ECB) maintains a hawkish stance and has warned markets of more hikes to come, with President Lagarde saying that they have made “significant progress” but “cannot declare victory yet.” The Bank of England (BoE) has resorted to shocking the market with 50bps hikes as upside inflation surprises persist. While we don’t think that the inflation metrics in Europe share the same shelter price distortions as in the US, we know that monetary policy lags are long and variable. The rapid pace of rate hikes could have an outsized impact once the lag is accounted for.
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The Federal Reserve Bank of New York model which uses the term spread between 10 year and three-month Treasury yields to forecast recession 12 months out.
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Gold: a haven in times of economic stress?
Gold tends to perform well in times of economic stress. As Figure 2 below shows, when composite leading indicators (Figure 3) turn strongly negative, gold performs positively while equities tend to be negative. Gold also outperforms Treasuries, which are seen as competing defensive assets.
Figure 2: Gold prices in different phases of economic cycle
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Source: WisdomTree, World Gold Council, Metal Focus, GFMS. 1971 – 2022. Historical performance is not an indication of future performance and any investments may go down in value.
Figure 3: Composite lead indicator of economic conditions
Central bank buying of gold continues unabated in 2023. Global gold reserves rose by 114 tonnes in Q1 2023. That marks the strongest start to the year in terms of central bank buying gold since 2010. Maintaining such momentum after 2022 is an accomplishment. China has reported gold purchases for five consecutive months now.
Source: WisdomTree, Bloomberg, Organisation for Economic Cooperation and Development. Period June 1989 to May 2022. The composite leading indicator (CLI) is designed to provide early signals of turning points in business cycles, showing fluctuation of the economic activity around its long-term potential level. CLIs show short-term economic movements in qualitative rather than quantitative terms. CLI is amplitude adjusted, Long-term average = 100. Figure 3 shows when the strength of the signal while Figure 2 shows the historic asset price performance. Calculations are based on monthly returns in EUR. Europe Equities is proxied by the STOXX Europe 600 net total return index. Global Equities is proxied by the MSCI World net total return index. EUR Treasury is proxied by Bloomberg Barclays EUR Treasury TR Index Family. Gold is proxied by the LBMA Gold Price PM Index. Historical performance is not an indication of future performance and any investments may go down in value.
Base
Bear
Bull
After hitting an all-time high in 2022, central bank demand for gold has maintained strong momentum. Figure 4 shows official sector gold buying in Q1 2023 was the largest on record for the first quarter (albeit lower than Q3 2022 and Q4 2022). In April 2023 gold sales by Turkey’s central bank of 81 tonnes appears to be more of a technical dynamic than a change in gold buying policy: the gold was sold to the domestic public markets to satisfy strong bar, coin, and jewellery demand following a temporary partial ban on gold bullion imports. That ban was put in place to soften the economic blow from the earthquake in February 2023. A YouGov poll, sponsored by the World Gold Council , showed that developing market central banks are expecting to increase their gold reserve holdings and decrease their US dollar reserve holdings.
Central banks lapping up gold
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Figure 4: Central bank gold purchases by quarter
Source: WisdomTree, World Gold Council, Metal Focus, GFMS. Q1 2010 – Q1 2023. Historical performance is not an indication of future performance and any investments may go down in value.
If we look to WisdomTree’s quantitative gold model (see our model described in Gold: how we value the precious metal) to find out what has been driving gold prices recently, we can see that inflation is moderating, thus providing less support for gold prices than last year (Figure 5). The recovery in investor sentiment towards gold (measured by speculative positioning) has largely plateaued. The extension of the debt ceiling, and the passing of the mini banking crisis without any major systemic impacts (yet), has softened investor demand for the metal. However, dollar depreciation (relative to a year ago) acts as a support for the metal.
Looking back at gold
Figure 5: Gold price attribution
Source: Bloomberg, WisdomTree price model, data as of June 2023. The fitted gold price is the price the model would have forecast. The constant does not have economic meaning but is used in econometric modeling to capture other terms. It can be thought of as how much gold prices would change if all other variables are set to zero (although that would be unrealistic). Historical performance is not an indication of future performance and any investments may go down in value.
2023 Central Bank Gold Reserves Survey, May 2023.
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Bear Scenario
In the bear scenario, the Fed moves much more aggressively and, in doing so, pushes 10-year bond yieldsmuch higher. The Fed will be successful in bringing inflation down below 2% and so gold will no longer have any inflationary support. The US dollar will also appreciate (marginally) faster than in the base case, as the Fed is more hawkish than other central banks. Investor interest in the metal falls further to roughly half the net long positioning seen in September 2022.
Bull Scenario
In this scenario (which is a less likely scenario), the Federal Reserve stops raising interest rates earlier.
That eases the upward pressure on 10-year bond yields. It also reduces the interest rate differential between the US and other countries, helping the US dollar to depreciate. Stopping the rate tightening cycle early will, however, let inflation run higher than we expect in a base case scenario. In this bull scenario, investor sentiment toward gold picks up from relatively subdued levels to 150k net long for the forecast horizon. In this scenario gold could rise to $2330/oz by the end of September 2023 from $1720/oz at the beginning of September 2022.
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Source: WisdomTree Model Forecasts, Bloomberg Historical Data, data available as of close June 2023. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
Inflation forecast
Nominal 10-year yields
forecast
US$ exchange rate
forecast (DXY)
Speculative positioning forecast
Gold price forecast
Q3 2023
Q4 2023
Q1 2024
Q2 2024
3.5%
3.8%
2.6%
3.63%
3.53%
3.46%
3.42%
101.3
98.3
96.8
180k
125k
100k
US$2060/oz
US$2140/oz
US$2250/oz
US$2225/oz
Source: WisdomTree. Bloomberg Survey of Professional Economists, April 2023. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
Consensus
Inflation forecast
Q3 2023
Q4 2023
Q1 2024
Q2 2024
5.0%
4.5%
4.0%
3.5%
US$2200/oz
US$2330/oz
US$2495/oz
US$2490/oz
3.20%
3.00%
2.90%
100
98
96
94
200k
200k
200k
200k
Nominal 10-year yields
forecast
US$ exchange rate
forecast (DXY)
Speculative positioning forecast
Gold price forecast
Source: WisdomTree, June 2023. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
Bull
3.10%
Inflation forecast
Q3 2023
Q4 2023
Q1 2024
Q2 2024
3.0%
2.8%
2.4%
1.8%
US$1870/oz
US$1860/oz
US$1800/oz
US$1710/oz
4.10%
4.25%
4.25%
104
108
110
90k
75k
50k
Nominal 10-year yields
forecast
US$ exchange rate
forecast (DXY)
Speculative positioning forecast
Gold price forecast
Source: WisdomTree, June 2023. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
Bear
4.25%
106
80k
Figure 6: Gold price forecasts
Consensus
Bull case
Bear case
Our consensus scenario takes Bloomberg Survey of Professional Economists’ average views on inflation, US dollar and Treasury yield forecasts. Consensus is looking for inflation to continue to decline (although above central bank target), the US dollar to depreciate, and bond yields to continue to fall.
Without a consensus forecast on gold sentiment we reduce speculative positioning to a conservative 100k, which is close the long-term average, from the elevated level of close to 180k in June 2023. The risk is clearly to the upside this year if a recession or financial dislocation materialises. Gold is a highly sought after asset in times of economic and financial stress, and so a recession could drive sentiment for the metal even higher.
In the consensus case scenario, gold reaches US$2,225/oz by Q2 2024, piercing through previous all-time nominal highs (US$2,061/oz on 7 August 2020) by Q4 2023 at $2139/oz. However, in real terms this does not reach an all-time high, which was reached in January 1980. In fact, it would be 34% below that level. And, in real terms, it is still 10% below the 2020 high.
Consensus
Professor Jeremy J. Siegel of Wharton Business School, and an advisor to WisdomTree, believes current Fed hawkish is not warranted and inflation is already falling faster than published figures suggest (see My Bottom-Line Year-Ahead Outlook). Moreover, he expects the Fed to recognise what he deems to be a mistake and cut interest rates to 2-3% by year end and that 10-year yields will fall 2.9%. Even if the Fed cuts rates later this year, given long lags between policy choices and inflation outcomes, we could see inflation fall to 2% by end of year. That is basically at Fed target. If we go back to monetary expansion, central bank largesse will no longer be curtailed, and we can see a strong case for investors holding more gold exposure. In this case we keep positioning in gold futures at 150k net long (only slightly down from today’s level of 170k).
In this scenario, gold rises to US$2135/oz, aided by falling bond yields.
Siegel case
In this scenario the Federal Reserve pays heed to the recession warning signs and pivots its monetary policy to cutting rates faster. If the Fed begins monetary expansion by autumn 2023, bond yields will be falling and, assuming it moves before the European Central Bank and other major central banks, we could see the US dollar depreciate at a faster rate. We assume inflation will be stronger than in the consensus scenario as a result of the Fed loosening monetary conditions. Assuming that the recession fears that the Fed is responding to are real, we expect positioning in gold futures to remain elevated.
In this scenario, gold could reach US$2490/oz. That would be 22% higher than the all-time nominal high (reached in August 2020) and about the same level as that in real terms. However, it would be 28% below the all-time real high reached in 1980.
Bull case
In the bear case, CPI inflation falls to 1.8%, that is, below the Fed target. In essence, the Fed makes a policy error in overdoing the tightening. Bond yields rise and the US dollar appreciates as an overzealous Fed outpaces other central banks. Although we acknowledge that such a scenario increases recession risk and, therefore, could be gold positive drawing more investors to the yellow metal as a hedge, for the sake of building a negative scenario, we cut speculative positioning in gold futures down to 50k.
In this scenario, gold could reach US$1710/oz, retracing prices back to November 2022 levels.
Bear case
Gold outlook using WisdomTree’s forecasts model
Using the same model, we can produce gold forecasts consistent with several macroeconomic scenarios (Figure 6).
Consensus
Bull
case
Bear
case
Consensus
Bull
case
Bear
case
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150k
99.7
3.2%
Important Information
Base
Bear
Bull
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