Gold is generally considered an inflation-proof investment or simply an inflation hedge. According to several experts, Gold’s performance hasn’t been satisfactory in 2022; its value went down by 20% in March this year. The supply of the US Dollar is much more flexible than that of Gold, which the Federal Reserve Bank can increase. As a result of its scarcity, Gold is resistant to inflation.
Despite the geopolitical uncertainties and inflation, the sluggish behavior is tied to the increasing interest rates and a strong US Dollar. Gold’s quality as a long-term investment hedge is expected to crystallize (grow) due to its intrinsic value and demand.
Many investors believe Gold’s performance in 2022 should have been better in the rising interest rates environment. Interestingly, most people don’t realize that Gold outperformed most investable assets. In fact, Gold stands third in a row based on performance, just behind Commodities and US Cash.
PS! Overall, commodities prices are high because of the ongoing energy crisis due to the war in Ukraine. That also affects the US dollar positively.
The four key drivers of Gold performance:
Gold has been riding the risk and uncertainty generated by geopolitical tensions and rising inflation this year.
While the Fed and other central banks have raised interest rates to control inflation, the bond market has suffered. It also needed to offset the opportunity costs of rising interest rates and a strong US dollar.
Yellow metal accomplished better than the model predicted outcome is a confirmation of its universal charm and the reply to multiple variable underlying factors. According to gold.org and the commonly used gold valuation model, Gold should have been down around 30% against the 20%. And to top it all, weakened positions in the Futures market and Chinese demand has put additional pressure on Gold.
Regardless of the slow start, the central banks globally have aggressively taken measures against rising inflation. The quickest to react, the Federal Reserve Bank of the US has incessantly been increasing interest rates. Last time, it raised 75 basis points matching its target of 3.25%. It is expected that FED will try to further stretch it by another 75-100 basis points by the end of the year. Comparably, the Bank of England and Swiss National Bank pumped the interest by 50 and 75 basis points, respectively. The other global central banks will soon follow in their footsteps.
Despite the slow start, central banks worldwide have aggressively combated rising inflation. The Federal Reserve Bank of the United States, the first to react, has been steadily raising interest rates. They increased 75 basis points last time, matching its target of 3.25%. The FED is expected to try to push it by another 75-100 basis points by the end of the year. In contrast, the Bank of England and the Swiss National Bank increased interest rates by 50 and 75 basis points, respectively. The rest of the world’s central banks will probably follow with similar rate hikes.
In hindsight, the US dollar’s strength and interest rates are still potential threats to Gold.
Because the rise in interest rates has been continuous, we expect the pressure to ease. When it happens, gold investors probably kick in and provide backup. Furthermore, the existing net short positions in Gold Futures are favorable, as short positions in the yellow metal have historically not lasted long.
Gold remains in strong demand by the central banks.
Lastly, as the geopolitical risk and uncertainty increase coupled with the economic slowdown, the more conservative investment strategy will eventually shift toward proven assets like Gold to mitigate losses.