APAC Gold Strategist & Gold Sales Specialist - Hong Kong
After posting 18% and 25% gains in 2019 and 2020, respectively, the gold price is on pace to close out 2021 with a slight negative return.1 Following last year when record strength in investment demand offset record weakness in the jewelry sector, 2021 has been a period of recalibration for gold — reverting toward longer-term trend levels among demand sectors, with the price seeking to consolidate at a new higher base.
Looking ahead to 2022, there are several reasons to remain optimistic about gold’s outlook. The continued battle against COVID-19 and new variants, disruptions due to supply bottlenecks, rising consumer and commodity prices, and monetary policy shifts point to the likelihood of higher volatility on the horizon. Particularly set against the backdrop of an ongoing global pandemic, these headwinds may prove beneficial for gold as it looks to resume its longer-term bull market which commenced at the onset of the previous tightening cycle by the Federal Reserve (Fed) in December 2015.
Here, we outline four macroeconomic themes that remain at the helm for gold’s 2022 outlook. Based on these themes, our base case outlook sees gold returning to long-term trend levels with a potential boost to the upside driven by further recovery in emerging markets, monetary and fiscal policy missteps, and heightened volatility.
Gold May Resume Longer-term Trend Following 2021 Consolidation
Theme 1: Recovery in Global Growth May Bolster Cyclical Gold Sectors
The global reopening and economic recovery that began in 2021 is expected to continue in 2022 and lead to above pre-pandemic real GDP growth rates. Growth in the US has seen the quickest recovery from pandemic lows in 2021.2 Led by vaccine distribution efforts and fiscal stimulus, the US is forecasted to grow 5.5% for the full year 2021 with this rate moderating in 2022 to 3.9%, still nearly twice the average growth rate of 2.2% from 2010-2019.3 Like the US, the European economy has shifted from recovery to expansion this year as vaccine distribution increased mobility within the region. According to the International Monetary Fund, advanced European economies are forecasted to expand in 2021 by 5.1% while moderating slightly in 2022 to 4.2%.4
In China and India — two of the key emerging economies for the gold market — signs point to further consumer recovery throughout 2022, potentially lending support for cyclical gold sectors (jewelry, technology, and industrial fabrication) which account for the majority of annual gold demand. China could close 2021 with 8% economic growth before slowing down to 5.6% in 2022,5 due to a stronger pullback in public spending and a weakening property market. In recent months, economic and credit concerns over China have intensified and, in response, China has initiated plans to stabilize debt growth to ease financial risks. However, this remains a tangible factor to account for that may drive broader market volatility globally in 2022. Turning to India, a core economy for gold jewelry demand, growth in 2022 is expected to reach 8.5% as recovery from the pandemic resumes.6
Recovery in these four economies remains key for gold next year as these are some of the most important markets for gold jewelry demand — particularly India, China and other emerging markets. Gold demand among jewelry and technology through Q3 2021 has already matched full-year 2020 total demand in these sectors.7 Expectations for full-year 2021 gold cyclical demand to return to pre-pandemic levels are high with this trend potentially continuing throughout 2022 as part of a base case scenario outlook for gold.
Above-trend Global Growth Points to Support for Gold Cyclical Demand Sectors
Theme 2: Higher Rate Volatility with Low Real Yields Persisting
Looking ahead to next year, a key factor of consideration for gold remains the path and speed of monetary policy among global central banks, particularly the Fed, which commenced tapering its asset purchases in November.
Historically, the 10-year Treasury real yield has served as a key driver for the gold price and this relationship may persist in 2022 with the Fed expected to begin hiking its policy benchmark rate. The 10-year Treasury real yield rose over 40 basis points from -1.07% to -0.63% in Q1 2021, leading to gold enduring its worst quarter since Q4 2016 and dragging down its overall performance in 2021.8 However, since Q1, the combination of declining Treasury yields and rising inflation expectations has kept real yields effectively unchanged from where they began 2021.9 Elevated inflation alongside Fed tightening that is likely to remain behind the curve may indicate continued expectations for lower real yield levels.
Real Yields Likely to Remain Negative in 2022 Lending Support to Gold Interest
Focusing on the expected timing of the Fed tightening cycle in 2022 may lead to higher overall volatility across markets. In terms of the impact on gold from higher US policy rates, examining previous monetary tightening cycles showcases that rising policy rates do not always serve as a headwind for gold’s outlook over the full cycle. The previous Fed tightening cycle which began at the end of 2015 illustrates that the Fed’s rate hikes are not necessarily bad for gold. Between December 2015 and July 2019 (when policy shifted back to rate cuts), the Fed raised its funds target rate nine times from the range between 0%-0.25% to 2.25%-2.50%. And the gold spot price rose nearly 35% from US$1,061/oz to US$1,431/oz during the same period.10 Investors should look beyond nominal policy rates and examine other factors such as real interest rates and/or the gold market’s supply and demand dynamics that may impact gold price movement. Rate volatility next year may be at hand, however. And with real yield levels likely to remain negative and low on a historical basis, the backdrop for gold remains overall accommodative.
Gold Advanced Higher During the Previous Fed Tightening Cycle
Theme 3: Investor Motivation Driven by Inflation Risks and Fiscal Spending
Inflation has been a growing risk for investors in 2021 and will likely remain so in 2022. Rising commodity and energy prices, global supply chain bottlenecks, and labor supply and demand mismatches are likely to persist and contribute to an elevated inflationary environment, particularly compared to the low inflationary regime of the prior decade.
US inflation numbers are currently running at multi-decade highs with the US Consumer Price Index (CPI), a broad measure of inflation, reaching 6.2% year over year as of October 2021.11 Gold does keep up with price fluctuations over time, but historically it tends to stand out during extreme price levels as a potential store of value. In fact, over the last 50 years gold has provided an average annual real return of 12.7% when US CPI exceeded 5%, compared to negative returns on average for both US equities and bonds (see figure below).12 Investors may seek to increase exposure to gold next year in response to a new elevated inflationary backdrop.
Investors May Shift Allocations from Financial Assets to Gold on Elevated Inflation
Furthermore, global economies leaning on fiscal stimulus to drive post-pandemic economic recoveries may exacerbate inflation concerns, especially as it relates to the US dollar (USD) outlook. The potential long-term USD weakness may also be supported by the significant increase in the government debt since 2020, with the debt level soaring from US$23 trillion at the start of 2020 to US$29 trillion as of October 31, 2021. Recent passage of a US$1 trillion infrastructure bill in the US alongside additional economic and spending packages will further add to the current debt level, which may add more downward pressures to expectations for the dollar over the medium term. Given the USD’s historically negative correlation with the spot price of gold,13 performance will likely remain a driver for the gold price in 2022. The USD may find short-term support as the Fed seeks to tighten its monetary policy. However, over the longer term, as Europe and emerging markets close the gap to the growth recovery in the US and as US fiscal spending continues, the USD’s upside may be limited.
Theme 4: Mean Reversion in Risk Assets May Spur Market Volatility
As 2021 comes to a close, the spotlight is on the significant run risk assets have achieved this year. Equity market valuations remain broadly stretched with certain segments carrying lofty valuations, while market volatility has broadly remained tame throughout the year. Additionally, low interest rate policies and increased liquidity from monetary policy continue to spur more risk taking in fixed income and credit markets. Given the strong rally in financial markets in 2021, the potential for a cyclical correction, valuation-driven mean reversion, increased market volatility, or an exogenous tail risk has increased in 2022.
Some potential areas of market risk include:
Elevated equity market valuations may be challenged against tightening profit margins from rising input prices and higher labor costs. This may cause a mean reversion or cyclical correction growth as expectations moderate.
Corporate bond spreads over Treasuries remain near their 2021 lows.14 The current combination of low risk-free rates and tight corporate bond spreads has made for structurally lower effective yields. An elevated debt burden against a rate tightening cycle could add stress to broader markets and increase volatility.
Geopolitical turmoil and headlines may spark broader market volatility with market participants closely monitoring several hot spots globally including but not limited to ongoing tensions between the US and China, Russian activity at the Ukraine boarder, and geopolitical instability in the Middle East and North Korea.
Cryptocurrencies have seen remarkable growth in value and public attention this year driven by speculative interest, but with this quick ascent comes the potential for a market correction that may spill over to broader financial markets leading to increased volatility, particularly as derivatives tied to cryptos continue to generate interest.
This potential for higher volatility may push investors to gold as a potential hedge against heightened market risks. Historically, gold has served investors well against short-term volatility shocks, both moderate and severe, as measured by rising levels of the VIX index (see figure below).15
Historically, Gold Is a Robust Option Against Various Degrees of Market Volatility
2022 Outlook Scenarios
Considering these major themes, we see three possible scenarios for gold’s outlook next year, with a slight upward skew reflecting the potential for upside surprises for gold.
Base Case: Our base case scenario for gold has a 50% likelihood of occurring, with a potential trading range between US$1,800/oz and US$2,000/oz. Under this scenario, the Fed hikes one or two times, real yields rise but remain negative on average for the year, and the USD remains flat. Additionally, global growth remains flat with jewelry demand reaching pre-pandemic trend levels. Volatility rises but remains moderate.
Bull Case: Our bull case scenario for gold applies a probability of 30%, with a potential trading range between US$2,000/oz and US$2,200/oz. In this scenario, real yields remain deeply negative as the Fed remains more dovish than expected, hiking no more than once, as inflation plateaus but remains elevated. Emerging market economies outpace US growth, spurring further pressure on the USD. Volatility rises significantly driven by exogenous market shocks and tail events which increases investment demand for gold and gold-back ETFs.
Bear Case: Our bear case scenario, with 20% probability, reflects a trading range sliding closer to pre-pandemic levels from US$1,600/oz to US$1,800/oz. Under this scenario, the Fed begins tightening rates faster than market expectations (more than twice), but US growth remains strong. Volatility dampens while investors rotate into risk assets, pushing real yields dramatically higher. US outperformance versus the rest of world also supports a stronger USD, while emerging market economic recovery stumbles, dampening consumer demand for gold jewelry.
Gold Heads into 2022 with Upside Risks Outweighing Downside Risks
1Gold spot price in US dollars was down 6.52% year to date. Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 2Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 3Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 4Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 5Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 6Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 7World Gold Council, State Street Global Advisors. Data as of September 30, 2021. 8Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 9Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 10Bloomberg Finance L.P., State Street Global Advisors. Data from December 15, 2015 to July 30, 2019. 11Bloomberg Finance L.P., State Street Global Advisors. Data as of October 30, 2021. 12Bloomberg Finance L.P., State Street Global Advisors. Data from August 31, 1971 to October 31, 2021. 13Bloomberg Finance L.P., State Street Global Advisors. Gold has averaged a -0.38 correlation to the US. Data from August 31, 1971 to November 30, 2021. 14Bloomberg Finance L.P., State Street Global Advisors. Data as of November 30, 2021. 15Bloomberg Finance L.P., State Street Global Advisors. Data from January 1, 1990 to November 30, 2021.
Bloomberg Commodity Index
A broadly diversified commodity price index distributed by Bloomberg Indexes that tracks 22 commodity futures and seven sectors. No one commodity can compose less than 2 percent or more than 15 percent of the index, and no sector can represent more than 33 percent of the index.
Bloomberg Emerging Markets USD Aggregate Bond TR Index
A flagship hard currency Emerging Markets debt benchmark that includes USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers.
Bloomberg U.S. Aggregate Bond Index
A broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
Bloomberg US Corporate High Yield Index
An unmanaged index that is comprised of issues that meet the following criteria: at least $150 million par value outstanding, maximum credit rating of Ba1 (including defaulted issues) and at least one year to maturity.
Bloomberg U.S. Corporate Investment Grade Index
Measures the investment grade, fixed-rate, taxable corporate bond market.
Bloomberg U.S. Treasury Index
Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.
Dollar Index / US Dollar Index (DXY)
A currency benchmark that measures the performance of the US dollar against a basket of currencies: the euro (EUR), the yen (JPY), the British pound (GBP), the Canadian dollar (CAD), the Swiss franc (CHF) and the Swedish krona (SEK). Its shorthand symbol in financial markets is “DXY.”
HFRX Global Hedge Fund Index
The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies, including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The strategies are asset weighted based on the distribution of assets in the hedge fund industry.
MSCI EAFE Index
An equities benchmark that captures large- and mid-cap representation across 22 developed market countries around the world, excluding the US and Canada.
MSCI Emerging Markets Index
The MSCI Emerging Markets Index captures large and mid-cap representation across 23 emerging markets countries. With 834 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
S&P 500 Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.
Spot Gold Price
The price in spot markets for gold. In US dollar terms, spot gold is referred to with the symbol “XAU,” which refers to the price of one troy ounce of gold in USD terms.
US CPI Urban Consumers NSA Index
Measure of prices paid by consumers for a market basket of consumer goods and services.
VIX Index or CBOE Volatility Index (VIX)
The VIX, often referred to as the equity market’s “fear gauge,” is a measure of market risk based on expectations of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options—both calls and puts. The VIX volatility measure is meant to be forward looking.
The views expressed in this material are the views of the Gold Strategy Team as of November 30, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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