Elena_95 Gold Outlook 2023: The global economy at a crossroads

Gold Outlook 2023: The global economy at a crossroads


The global economy is at an inflection point after being hit by various shocks over the past year. The biggest was induced by central banks as they stepped up their aggressive fight against inflation.

Going forward, this interplay between inflation and central bank intervention will be key in determining the outlook for 2023 and gold’s performance.

Economic consensus calls for weaker global growth akin to a short, possibly localized recession; falling – yet elevated – inflation; and the end of rate hikes in most developed markets. In this environment which carries both headwinds and tailwinds for gold, our key takeaways are:



~Mild recession and weaker earnings have historically been gold-positive

~Further weakening of the dollar as inflation recedes could provide support for gold

~Geopolitical flare-ups should continue to make gold a valuable tail-risk hedge

~Chinese economic growth should improve next year, boosting consumer gold demand

~Long-term bond yields are likely to remain high but at levels that have not hampered gold historically

~Pressure on commodities due to a slowing economy is likely to provide headwinds to gold



On balance, this mixed set of influences implies a stable but positive performance for gold
That said, there is an unusually high level of uncertainty surrounding consensus expectations for 2023. For example, central banks tightening more than is necessary could result in a more severe and widespread downturn. Equally, central banks abruptly reversing course – halting or reversing hikes before inflation is controlled –could leave the global economy teetering close to stagflation. Gold has historically responded positively to these environments.

On the flip side, a less likely ‘soft landing’ that avoids recession could be detrimental to gold and benefit-risk assets.



Bumpy road ahead

Economic growth: short sharp pain
There are now many signs of weakening output due to the speed and aggressiveness of hiking moves by central banks. Global purchasing manager indices (PMI), now in contraction territory, indicate a deepening downturn across geographies, and economists are warning of a material recession risk

Consensus forecasts now expect global GDP to rise by just 2.1% next year. Excluding the global financial crisis and COVID, this would mark the slowest pace of global growth in four decades and meet the IMF’s previous definition of a global recession – i.e. growth below 2.5%.


Policy and inflation: higher for longer
It is almost inevitable that inflation will drop next year as further declines in commodity prices and base effects drag down energy and food inflation. Furthermore, leading indicators of inflation tell a consistent story of a moderation.



This brings us to the implications for monetary policy. The policy trade-off for nearly every central bank is now particularly challenging as the prospect of slower growth collides with elevated, albeit declining inflation.

No central bank will want to lose its grip on inflationary expectations resulting in a strong bias towards inflation fighting over growth preservation. As a result, we expect monetary policy to remain tight until at least mid-year.

In the US, markets expect the Fed to start cutting rates in the second half of 2023. Elsewhere, markets expect policy rates to come down more slowly than in the US, but by 2024 most major central banks are expected to be in easing mode.


Macroeconomic implications for gold
Gold is both a consumer good and an investible asset. As such, our analysis shows that its performance is driven by four key factors and their interactions:


1-Economic expansion – positive for consumption

2-Risk and uncertainty -- positive for investment

3-Opportunity cost – negative for investment

4-Momentum – contingent on price and positioning.


These factors, in turn, are influenced by key economic variables such as GDP, inflation, interest rates, the US dollar, and the behavior of competing financial assets.



Recession: portfolio ballast
A challenging combination of reduced but still elevated inflation and softening growth demands vigilance from investors. The likelihood of recession in major markets threatens to extend the poor performance of equities and corporate bonds seen in 2022.


US dollar: trending down
After strengthening for nearly two years straight, the US dollar index (DXY) has recently seen a steep drop, despite continued widening of – both actual and expected – rate differentials. It seems that reduced demand for dollar cash was the likely culprit.

Next year, we see a more complex dynamic driving the US dollar. First the shoring up of energy needs in Europe will, in the immediate future, continue to reduce pressure on the euro. Second, as central banks in Europe, the UK and Japan continue to take a more hands-on approach to their respective currency and bond markets some of the pressure on domestic exchange rates could ease. All things considered, the dollar is likely to be pressured particularly as falling inflation and slower growth take hold. And a dollar peak has historically been good for gold, yielding positive gold returns 80% of the time (+14% on average, +16% median) 12 months after the peak. Although currently very high in REER terms and likely one of the catalysts for the recent turn, the starting valuation for the DXY has been less important in determining the magnitude of gold returns.

Regards:
Elena_95

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