Where will gold prices go? It depends on the economy


Gold, traditionally a hedge against inflation and a safe haven investment in difficult market times, has not been an effective investment this year.

Inflation has been high. The consumer price index rose 8.5% in July from a year ago, slightly lower than the 9.1% year-on-year reading in June. And despite a recent rally in the US stock market, the S&P 500 index remains down 10% year-to-date. And gold’s theoretical enemy, bitcoin – which some pundits call “digital gold” – is down almost 50% on the year.

All of this suggests a perfect backdrop for gold to outperform, doesn’t it? Bad.

Although gold was not the worst performing asset class, it nonetheless languished. The price of gold has fallen more than 3% since January 1. The NYSE Arca Gold Miners Index is also down more than 16% for the year.

There are several reasons for this, despite the seemingly ripe conditions.

First, the price of gold is in US dollars. Thus, the stronger the dollar, the fewer dollars it takes to buy an ounce of gold. It is a mathematical and mechanical truism.

As US inflation soared, the Federal Reserve moved diligently to raise benchmark interest rates. And more importantly, investors still expect further interest rate hikes in the future. While many economists believe the Fed has lagged in “normalizing” interest rates, on a relative basis it has moved faster to raise rates than other national central banks.

High relative interest rates compared to other countries have attracted foreign investment flows to the United States and strengthened the US dollar. Since the beginning of the year, the dollar has appreciated by more than 11% against the euro and by more than 16% against the yen.

This dollar strength effectively capped gold’s performance.

The other deterrent is interest rates. The Fed’s rate hikes also pushed bond prices down. This means that the yield of various types of fixed income instruments, such as government, corporate, municipal and consumer debt, increases as their prices fall. Such a dynamic makes bonds an increasingly attractive investment.

A high interest rate is perhaps the most important factor against gold. Gold, as a commodity, does not pay a coupon. Thus, higher yields on bonds are an argument against investing in gold.

Since hitting an all-time high of around $2,100 an ounce in 2020, gold has been steadily falling.

So is gold’s allure as an inflation hedge and safe-haven asset class over?

It depends on which side of the fence you sit on when it comes to the outlook for the US economy.

The argument against gold lies in the belief that the central bank can control inflation by raising interest rates and managing a “soft landing” for the US economy and avoiding a deep recession.

This is indeed the thesis of Capital Economics, which predicts a year-end price of $1,650 for gold. This is not a huge drop from today’s price, but the modest decline would be driven by further strengthening of the dollar and the yield on 10-year Treasury bonds settling in the 3% range.

So far, that’s the path the Fed hopes for the domestic economy. Minutes from the August meeting showed that policymakers intended to raise interest rates and tighten monetary policy to a level that could restrain economic growth. While that’s always been the plan, there’s a fine line between restricting growth and causing a deep contraction.

But if you think the US economy is doomed and the central bank will come under pressure to cut rates to spur growth, then gold prices are likely to outperform.

Such an argument was made by economist Nouriel Roubini – aptly nicknamed “Dr. Doom” – in a recent interview with Bloomberg TV.

Roubini sees two options for the US economy. The first is that the Fed is aggressively raising interest rates in the 4-5.0% range, to the detriment of the economy. The other option is sustained high inflation of over 8% with relatively low interest rates, as the Fed would have no choice but to stop raising rates or even cut rates in due to the weak economy.

Jan Hatzius, chief economist at investment bank Goldman Sachs & Co., also believes the United States is struggling to avoid a deep recession.

Relatively high inflation and relatively moderate interest rates. This is an environment conducive to an outperformance of gold prices.

The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.


Fan Yu is an expert in finance and economics and has contributed analysis on the Chinese economy since 2015.

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