Should retail investors buy gold?

Gold loves uncertainty — something that is hardly missing in the world today.

Few thought that 2022 would deliver greater shocks after two years of pandemic-driven border closures, lockdowns and global supply chain snarls.

Yet the geopolitical turmoil triggered by Russia’s invasion of Ukraine and the ensuing energy crisis made 2023 even more volatile, sending gold prices surging to an all-time high above $2,000 per troy ounce in March as investors bought gold as a safe haven asset.

That was exactly as the gold bugs might have predicted. However, the bullion market is not so simple. The lustre came off the yellow metal as the year wore on as interest rate hikes aimed at fighting soaring inflation prompted institutional investors to sell gold as the higher yields on government bonds became too enticing to miss.

Gold now trades at about $1,780 per troy ounce, following the US Federal Reserve lifting interest rates from near zero to a range of 4.25 to 4.5 per cent, including this week’s hike. The Bank of England and the European Central Bank have also been raising rates. Still, that leaves the yellow metal above its September low of $1,600 and an $1,350 average price for the 2010s.

Christopher Louney, commodity strategist at RBC, calls this the “long-running tug of war” between negative financial factors pulling down on gold prices and the metal’s attraction as a store of value during inflationary and/or risky times.

But 2022 is coming to a close. What investors, including retail savers, need to know is what comes next. FT Money takes a look at what matters in the gold market and what doesn’t.

Pivot or no pivot?

For 2023, gold bulls and bears are poring over a complex range of factors from record central bank bullion purchases to China’s economic reopening and geopolitical risks, including the Ukraine war, the US-China political conflict over Taiwan, and tensions in the Middle East.

But the most heated debate centres on the interplay between inflation and central bank intervention.

“The biggest impact on gold prices is the Fed rate policy and US real yields. It’s all about the opportunity cost of holding gold,” says Bernard Dahdah, senior commodities analyst at Natixis, a French investment bank. “The big question is: ‘is the Fed going to pivot or not?’”

Higher yields on US government bonds push the dollar up as investors sell debt denominated in other currencies to profit from the better premiums on US Treasuries. That, in turn, has contributed to taking the shine off gold, which tends to trade inversely to the greenback.

“It’s quite a thing to hold gold when interest rates are zero, it’s another to hold them when they’re 4 per cent,” says Giles Parkinson, managing director of global funds at Close Brothers Asset Management.

Investors are assessing the effects of this week’s hike. Even though the Fed lifted rates by only 0.5 percentage points, following a series of 0.75 percentage point hikes, gold prices fell after the meeting as chair Jay Powell warned that he could not guarantee that the Fed’s forecast for peak interest rates would not be revised upwards again.

However, the consensus in the US markets remains that the central bank will start cutting rates in the second half of 2023. Paul Wong, market strategist at Sprott, an asset manager specialising in precious metals, says that gold as a safe haven is attractive because of the risk of recession and financial instability at a time when “the risk of massive rate hikes and a spiking US dollar are behind us”.

He argues that the Fed has signalled a slowdown in interest rate hikes after the better than expected US inflation reports. The US consumer price index fell on Tuesday to 7.1 per cent for last month, lower than the 7.3 per cent economists forecast, pushing gold above $1,800 on expectations that the US central bank could squeeze the economy less aggressively to tame inflation.

On Wong’s sums, these shifts led precious metals to be the best-performing asset group in November versus equities, the US dollar and bonds.

However, one piece of evidence supporting the contrary view that the Fed will stay in its fight to tame inflation, is that the gulf between short-and long-term US borrowing costs has reached its widest point in just over 40 years.

This month, the two-year Treasury yield traded at 4.2 per cent, while the 10-year yield stood at 3.4 per cent, bringing the difference between the two to 0.84 percentage points. The pattern, known as a yield curve “inversion”, has preceded every US economic downturn of the past 50 years.

Giovanni Staunovo, a commodity analyst at UBS, the Swiss bank which is the world’s largest wealth manager, says that “it’s too early to call for a Fed pivot” and “it’s not yet time to buy gold”. But he adds: “We believe in 2023 there will be a period where it’s interesting to buy gold when the market starts to smell that the Fed will cut interest rates.”

Debt crisis and persistent inflation

Gold bugs highlight the fears coursing through markets that things could yet turn out worse than the Fed hopes. Gold has proven its worth in previous economic downturns, delivering positive returns in five out of the last seven recessions since 1973, including in the 2008 global financial crisis and the 2020 Covid shock, according to the World Gold Council, an industry group.

Gold bugs argue that the huge levels of debt worldwide could force central banks to reverse course on monetary policy sooner rather than later.

Worldwide debt as ratio to gross domestic product at 247 per cent, is far higher than before 2007 when it was below 200 per cent, according to the IMF. Borrowing for pandemic spending has come on top of debts incurred during the global financial crisis and its aftermath.

Much debt is denominated in US dollars, the strength of which has made those loans bigger for borrowers in other currencies, while servicing has become more costly with rising interest rates.

Peter Marrone, chair of Yamana Gold, a Canadian gold mining company that was recently subject to a takeover battle, says that central banks cannot keep raising interest rates in the face of the growing debt burden facing poorer economies, something on which the World Bank renewed its warning this month.

“What happens to all of that debt when the dollar is going up, local currencies are devaluing and interest rates are going up,” says Marrone. “It just becomes untenable to maintain that and at some point central banks will have to recognise that.”

Marrone further warns that there is a high risk of returning to 1970s-style “dramatic inflation” because pricing pressures are being driven by systemic issues such as labour shortages and under-investment that monetary policy cannot solve.

In real terms, the all-time high gold price was actually hit in 1980 when it exceeded $800 per troy ounce, says Marrone. Adjusted for the present day value of the dollar would be close to $2,700 per troy ounce. That leaves a lot of road to run for gold prices now, he argues.

In a more measured view, Robert Crayfourd, manager of the CQS Natural Resources Growth & Income fund, says there is “real potential for things to fall over. We believe gold is relatively cheap insurance”.

However, even while acknowledging the short-term attractions of adding gold to portfolios in expectation of a Fed pivot, some fund managers see less of a long-term role for the yellow metal.

It faces a “generational headwind” from being poorly understood by young western investors more interested in crypto, as well as having no role in the green transition, says Nicky Shiels, head of metals strategy at MKS PAMP, a precious metals group.

It also produces no income — at a time when investors, especially the big institutions, have a wider range of income-generating portfolio asset choices than ever.

“The curse and blessing of gold is it doesn’t have any yield,” says Parkinson at Close Brothers. He adds that many equities will have strong earnings prospects even if recession strikes.

This argument would be still stronger if there is an unexpectedly smooth exit from high inflation into a solid economic recovery in the US and Europe. Such an environment, says Dahdah at Natixis, “is more bullish for equities than gold”.

Meanwhile, a successful post-Covid economic reopening by China could also be bearish for bullion, says John Reade, chief market strategist at the World Gold Council (WGC). “A pick-up in inflation could be a headwind for gold as the Fed could tighten more quickly. That could come from a China reopening.”

Pillars of price support

But the gold bulls have other big guns in their armoury. A key factor supporting gold has been the record level of central bank buying. Central banks bought almost 400 tonnes of gold in the third quarter — the largest since 2000 when records began — according to the WGC. Central bank bullion purchases for the first nine months of 2022 have outstripped any year since 1967.

Gold executives speculate that China and Russia were behind the purchases as they diversify holdings after western allies froze $300bn of Russia’s foreign currency reserves.

That was partially confirmed last week when the People’s Bank of China reported a 32-tonne rise in its gold holdings in November, the first increase in more than three years.

Moreover, central bank buying has been joined by a clamour for gold among retail investors.

They have snapped up bars and coins out of concern that inflation may be more persistent than professional money managers believe, according to WGC data. And they are perhaps more worried about the geopolitical risks, whether it is the Ukraine war or rising tensions over Taiwan.

“US retail investors seem to have adhered to the idea that gold bar and coin investments offer protection in periods of stubbornly high inflation and economic uncertainty,” says Alan Goldberg, an analyst at BestBrokers.

Jewellery purchases driven by consumers in China and India returned to normal pre-Covid levels in the third quarter of this year, while bar and coin demand was the strongest since 2011, growing 36 per cent year-on-year.

Furthermore, gold may benefit from the crisis in cryptocurrencies following the collapse of the exchange FTX. “With cryptocurrencies in the doldrums, we think gold stands alone as a non-debasable asset of last resort,” says Louney of RBC.

But central banks and retail investors aren’t the whole market. The biggest financial investors — institutions — have been unconvinced by the bull arguments until now.

Gold-backed exchange traded funds, dominated by institutional investors, have experienced outflows for seven consecutive months. Some fund managers say the exodus from gold ETFs could accelerate at the end of the year as portfolios come under review and the opportunity cost of holding gold comes into focus. Parkinson says: “If investors buy a lot of gold and open up that box in 10 years’ time, they will still have a lump of gold.”

The bulls retort that is all very well when the economic outlook is stable. But it’s not. Shaun Usmar, chief executive of Triple Flag Precious Metals, a metals financing company, says: “Do you think the world in 2023 will become more crazy or less crazy than it was in 2022?”

He may be right. However, 2022 also showed that investors can take even big shocks in their stride. Why shouldn’t they cope with 2023’s surprises just as well?