Gold 2023 Outlook: Recession and Rates to Remain in Focus

• Key considerations for gold in 2023 remain the path of global monetary policy and risk of global economic recession

• Gold may see strength in 2023 driven by a pause in monetary policy tightening, a weaker US dollar, and continued volatility from global uncertainty

• Gold demand globally remains robust which may support a brighter outlook in 2023
  

Gold’s performance throughout 2022 could be summarized simply as “surprising.” For some investors, gold was surprising as it did not live up to performance expectations despite several supportive catalysts for the price, including: rising equity market volatility as indices broadly entered a bear market; the Russian invasion of Ukraine raising the specter of long-lasting geopolitical turmoil in Europe; and multi-decade-high inflation weighing on the global growth outlook.

Conversely, other investors found gold surprising in its endurance to portfolios and how well gold held up in the face of the Federal Reserve (Fed) aggressively increasing interest rates, rising real yields, the US dollar hitting a 20-year high,¹ and sporadic lockdowns in China impacting gold demand.

In our view, the truth is somewhere in the middle since, on a relative basis, gold did quite well throughout 2022 (see Figure 1). Gold outperformed global stocks and bonds, and provided portfolio diversification while also testing its all-time-high price in US dollars after reaching US$2070/oz in early March.²

These conflicting perspectives may persist into 2023. The biggest headwind that still remains is the path of Fed rate tightening, particularly in the first half of 2023. Stronger tailwinds may emerge in the latter half of 2023 as gold aims to resume its long-term upward trend. Overall, the outlook for gold next year may be buoyed by:

• a potential pause or even pivot in the Fed’s monetary policy against growing recession risks
• waning US dollar strength as other global currencies experience mean reversion
• total global demand for gold maintaining current levels
• greater economic uncertainty and ongoing geopolitical turmoil driving market volatility and demand for downside protection among investors

Theme 1: Balancing Act by Monetary Policymakers May Raise Risk of Global Recession

The Fed’s hawkish turn to combat rising price inflation in 2022 came at an unprecedentedly aggressive pace. The Fed increased its policy benchmark by 375 basis points (bps) over the course of six months,³ applying four consecutive 75bps hikes and bringing its policy rate to the highest level since 2008.⁴ These actions were felt across capital markets, with broad-based equity indices falling by double digits. Additionally, the US 10-Year Treasury yield more than doubled to 3.61% in 2022.⁵ Meanwhile, US real yields rose over 230bps from -1.10% at the start of year to +1.24% as of November 30, 2022.⁶

The Fed may have broadly achieved its target goal of “squashing” inflation, given the decline in market expectations for US inflation and correction in financial assets. As a result, it seems more likely that the Fed may slow its pace or pause its hiking cycle in the first half of 2023. The gold price declined in response to these shifting interest rate levels, while also closely tracking the decline in inflation expectations (see Figure 2). Despite this, gold held up better than historical averages would suggest, particularly given the sharp rise in real yields. This likely was due to rising investment demand from persistent global inflation, financial market volatility, and geopolitical turmoil, but also growing concerns that the continued aggressive interest rate path could spark risks to the broader financial system and potentially push the US, and in turn the global economy, into a recession.

With the likelihood of a US recession growing, gold may benefit from investors trying to pivot towards counter-cyclical and defensive portfolio positioning. Gold’s behavior during previous recessionary periods in the US is clearly in favor of the yellow metal. Gold’s performance during other cyclical phases shows that on average, gold also fares well outside of recessions. Gauging leading economic indicators⁷ shows that gold has typically done well in three of the four phases of a full economic cycle (see Figure 3). On an average monthly basis, gold has done best during periods of recession and slowdown, during which it has outperformed US equities, US Treasurys, commodities and the US dollar. Even during periods of US economic recovery, gold has shown positive returns while keeping pace with other defensive portfolio assets such as Treasurys and the US dollar.

Theme 2: Strong Dollar Peaks As US Rates Plateau

Another result of the jump in US nominal and real interest rates was a surge in the US dollar relative to other currencies. The emergence of a US dollar bull market in 2022 was certainly unexpected, and growing demand for the greenback pushed its spot index to the highest level since 2002 (see Figure 4).

Given the historical negative correlation between gold and the US dollar, gold came under pressure in the strong dollar environment that emerged this year. But expectations for a monetary policy pivot or pause in 2023, along with mean reversion in other global economies, may put pressure on the US dollar. This may lead to renewed interest in gold among US investors seeking to hedge against a more temperate US dollar environment.

Non-US gold investors saw a stark contrast in gold price performance (see Figure 5). Gold in Japanese yen, British pound, and euro terms carried positive returns in 2022 for local currency investors. Additionally, gold in emerging market currencies, such as the Chinese yuan and Indian rupee, saw significant outperformance versus the US dollar price of gold.

This dynamic of currency depreciation globally, whether it be deliberate (a result of a strong US dollar as well as rising wage and commodity prices) or accidental (through fiscal policy missteps such as in the United Kingdom in 2022), highlights the store-of-value aspect gold offers investors. This partly explains why, despite rising US rates and a strong US dollar, global investment demand for gold rose: to protect against depreciating currencies and loss of spending power due to inflationary pressures. Gold also benefited from serving as a potential hedge against rising volatility of global stocks and bonds, in particularly emerging markets, which have been significantly impacted by the rising US dollar and interest rates.

Looking ahead, a correction in the US dollar from its current lofty level may portend renewed interest in gold among US investors — alongside a global investor base that has been very happy with gold’s performance recently. The end result may be a more evenly balanced investment demand for gold globally.

Theme 3: Fundamental Demand Supports Robust Gold Outlook

Global demand for gold in 2022 was strong among key sectors including investments, jewelry, and central banks (see Figure 6). In fact, looking at average quarterly demand for the past five years, the pandemic had a material impact on gold demand, with a quarterly average of 913 metric tons in 2020 compared to the 2018-2019 quarterly average of approximately 1,102 metric tons.⁸ Since the drop in 2020, however, the average quarterly demand from 2021-2022 was 1058 metric tons — returning closer to its’ pre-pandemic pace and in line with longer-term trend levels.⁹ This is a healthy sign that the fundamental drivers for gold are on strong footing heading into 2023.

Headwinds like ongoing targeted COVID lockdowns in China may impact demand in that region, but strong investment demand in Europe and global central bank buying in 2022 are key trends that may persist into next year. Central bank net buying in particular was a source of significant demand, with an estimated quarterly record of 400 tons of gold added to central bank holdings in Q3. This brought the year-to-date 2022 central bank gold demand on par with record levels for full-year demand in 2018 and 2019.

Investment activity in response to the current monetary policy and macroeconomic environment may continue to drive the gold price into early 2023, but there are encouraging signs that global gold investment demand remains robust with potential further growth in this sector.

Global investment demand for gold saw a bifurcation in 2022 between retail bar and coin demand and gold ETF demand. While global gold ETF demand has experienced volatility (year-to-date demand is 6.7 metric tons as of Q3¹⁰), retail bar and coin investment demand has seen steady growth (see Figure 7). In Q3 2022, bar and coin demand hit its highest quarterly level since Q1 2021 — led by Turkey, China, and India — and on a year-to-date basis, Europe accounts for the largest bar and coin demand. Growth among bar and coin gold demand globally highlights a persistent, sticky demand for gold investment. Overall, this is a positive sign that gold investment may see further support, particularly in an uncertain macroeconomic landscape in 2023.

Theme 4: Greater Uncertainty Led by Geopolitical Risk

Focusing only on gold’s -3.3% year-to-date return¹¹ overlooks the benefit gold brought to diversified portfolios. 2022 saw an equity bear market, the Russian invasion of Ukraine, multi-decade-high inflation, and a breakdown of the traditional negative correlation between stocks and bonds. Taking these factors into account, gold weathered this market environment quite well. In fact, a global 60/40 stock/bond portfolio with a prorated 10% allocation to gold outperformed a portfolio without gold by 1.96% year to date (see Figure 8).

During the first half of 2022, when the S&P 500® Index experienced a 20% drop, a portfolio with gold outperformed by nearly 200bps. In the second half of the year, despite an equity market rally, gold served as a key portfolio diversifier, nearly matching performance of a portfolio without gold. Ultimately, 2022 was a case study on the benefits gold may bring to portfolios due to its distinct risk management capabilities.

The 2022 theme of uncertainty driving volatility will likely remain a top investment consideration in 2023. Potential market risks in 2023 include but are not limited to:

• Global recession and economic slowdown led by monetary policy missteps
• Rising and ongoing geopolitical tensions in Ukraine, Taiwan, North Korea, and Iran
• Elevated commodity prices and rising prices weighing on consumer demand
• Earnings cycle recession adding to volatility in equity markets
• Tight labor market and sticky wage inflation may prolong inflation and weigh on global growth outlook

Gold may serve as a viable tool for investor risk mitigation against the potential for ongoing volatility. Historically, gold has outperformed stocks, bonds, the US dollar, and oil during periods of heightened volatility. This has been the case based on average monthly returns for not just implied equity market volatility, but also interest rate and currency volatility (see Figure 9). As uncertainty persists, investors may continued to turn to gold as part of a diversified portfolio risk mitigation strategy.
 

2023 Gold Outlook Scenarios

Considering these themes, three scenarios for gold’s outlook next year emerge — with a slight upward skew reflecting the potential for upside surprises for gold. This creates a barbell of outcomes with equal weighting for bear and bull cases, and an overall higher probability of a base case scenario outcome.

• Base Case (60% Probability): Gold sees a potential trading range between US$1,600/oz and US$1,900/oz. Under this scenario, the Fed pauses its current interest rate tightening cycle by mid-2023, with US growth slowing more than expected but avoiding a deep recession. As a result, the US dollar weakens slightly while global gold demand remains along long-term trend levels.
• Bull Case (20% Probability): Gold’s potential trading range is between US$1900/oz and US$2,000/oz. In this scenario, the Fed pivots and begins to cut interest rates in response to deteriorating economic data as the US heads into a prolonged economic recession. The US dollar moderates from its peak, and global demand for gold exceeds long-term trend levels, led by investment flows.
• Bear Case (20% Probability): Gold’s trading range slides closer to pre-pandemic levels, from US$1,500/oz to US$1,600/oz. Under this scenario, the Fed proceeds with its aggressive tightening path to bring down inflation while avoiding recession. Meanwhile, investment demand for gold falls as risk assets rally, and gold demand in China weakens throughout 2023 due to its zero-COVID policy and strict lockdown measures.

You can access more commentary from the Gold Strategy team here.