WisdomTree’s Shah gives Gold Outlook to Q4 2023

by | Feb 21, 2023

Gold Outlook to Q4 2023: Gold could hit a nominal high…but a real high looks out of reach, says WisdomTree’s Head of Commodities and Macroeconomic Research, Nitesh Shah.

Gold’s fortunes appear to be turning in early 2023. Using consensus economic forecasts[1], our model[2] indicates gold could easily reach a new ‘nominal’ high this year (last reached in 2020). However, reaching a ‘real’ high (accounting for erosion due to inflation) looks out of reach. Even in our bull case, gold will be shy of those levels and some 11% below the real high reached in 1980. In a scenario where inflation falls drastically (Siegel case) and the Federal Reserve (Fed) makes an early pivot, gold prices stand to do well as bond yields decline more than in the consensus scenario (and using a lower level of inflation, the real value of gold is less discounted).

Source: WisdomTree Model Forecasts, Bloomberg Historical Data based on the London Bullion Market Association (LBMA) and Bureau of Labor Statistics data, January 1947 to December 2022. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties

Tough times for models

2021 and 2022 proved to be some of the toughest times to forecast gold. Even inputting the known outcomes for inflation, bond yields, exchange rates, and investor sentiment into our model[3], residuals (difference between model and actual outcomes) were greater than normal. Between May 2021 and May 2022, our model overestimated gold prices and between May 2022 and Dec 2022, it underestimated gold prices. But, by the end of 2022, our model and reality were closely aligned.

Source: Bloomberg, WisdomTree price model, data as of December 2022. The fitted gold price is the price the model would have forecast. The constant does not have economic meaning, but is used in econometric modeling to capture other terms. It can be thought of as how much gold prices would change if all other variables are set to zero (although that would be unrealistic).

Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

Looking forward, there is great uncertainty as to the path of the US dollar, bond yields, and inflation, so forecasting will not be any easier, but the model has been quite effective at understanding the key drivers of gold.

Headwinds removed and tailwinds present

In 2022, gold experienced tremendous headwinds from rising bond yields and an appreciating US dollar. So, despite inflation running at a multi-decade high, gold performance was, essentially, flat.

In the opening weeks of 2023 (and the tail end of 2022), these headwinds began to reverse. The US dollar has been depreciating and bond yields look to have peaked out in October 2022, giving gold some breathing room.

Additionally, and possibly most importantly, investor sentiment towards gold has turned the corner and is improving markedly. Sentiment had fallen to the lowest levels since April 2019 in September 2022.

While inflation seems to have peaked in 2022, it is elevated and possibly could remain above central bank targets for the remainder of this year (supporting gold).

Investors recognising the extent of uncertainty and potential for policy missteps of either over-tightening (and inducing a recession) or not tightening enough (and having inflation remain above target for an even more protracted period of time) are seeking financial hedges with their trusted asset: gold.

Gold is outperforming bonds

In 2022, real bond yields rose from -1.1% at the beginning of the year to 1.6% at the end of the year, marking the most aggressive bond sell-off in decades. Gold, meanwhile, held flat (-0.3% year-on-year), although intra-year it had peaked above US$2000/oz and fallen close to US$1600/oz. The extent of the bond sell-off has, however, weighed on gold. The metal would be trading much higher on account of elevated inflation were it not for the rising real rates. Now that real rates have started to fall once again (since October 2022), one headwind has been removed off gold.

Source: WisdomTree, Bloomberg. April 2017 – January 2023. Historical performance is not an indication of future performance and any investments may go down in value.

US dollar depreciation is now helping gold

Through most of 2022, US dollar appreciation weighed on gold prices in US dollar terms. However, since October 2022 the US dollar has been depreciating, aiding gold prices higher. Bond and US dollar trends indicate markets believe we are closer to the end of the Fed tightening cycle and there is potential for a ‘pivot’ towards a looser monetary setting some time this year.

Source: WisdomTree, Bloomberg. January 2020 – January 2023. Historical performance is not an indication of future performance and any investments may go down in value.

Investor sentiment towards gold is recovering rapidly

Sentiment towards gold, measured by speculative positioning in gold futures, had fallen to the lowest levels since April 2019 in September 2022. Under the weight of rising bond yields and an appreciating US dollar, gold did not appear to offer much reprieve against the highest inflation reading since 1981, nor the sharpest equity sell-offs since the Global Financial Crisis.

However, as bond and US dollar headwinds lessened, we moved past peak bearishness in the metal. Digital assets – which were often compared to gold as pseudo currency assets – had a terrible year in 2022. It became clear to many investors that gold and digital assets behave very differently. Many investors realised that they should be considered complementary rather than competing assets. As FTX imploded in November 2022, sentiment towards gold fired up. Although net speculative positioning in gold is still far from the (trailing 1-year) high of 321k reached in March 2022 (shortly after the start of the Ukraine war) it is rebuilding rapidly. While investors are more optimistic about a pivot in central bank policy, they realise such an outcome is far from certain and recession risks loom if they tighten too far. Gold is often seen as a defensive hedge.

Source: WisdomTree, Bloomberg. April 1995 – January 2023. Historical performance is not an indication of future performance and any investments may go down in value.

Gold outlook using WisdomTree’s forecasts model

Consensus

Our consensus scenario takes Bloomberg Survey of Professional Economists’ average views on inflation, US dollar and Treasury yield forecasts. Consensus is looking for inflation to continue to decline (although above central bank target), US dollar to depreciate, and bond yields to continue to fall.

Without a consensus forecast on gold speculative positioning, we input a conservative base case here of 100k, which is close to the long-term average. The risk is clearly to the upside this year if a recession materialises. Gold is a highly sought-after asset in times of economic and financial stress, and so a recession could drive sentiment for the metal even higher.

In the consensus case scenario, gold reaches US$2,082/oz by Q4 2023, piercing through previous all-time nominal highs (US$2,061/oz on 7 August 2020). However, in real terms this does not reach an all-time high, which was reached in January 1980. In fact, it would be 19% below that level; and in real terms it is still 11% below the 2020 high.

Siegel case

Professor Jeremy J. Siegel of Wharton Business School, and an advisor to WisdomTree, believes current Fed hawkish is not warranted and inflation is already falling faster than published figures suggest (see My Bottom-Line Year-Ahead Outlook). Moreover, he expects the Fed to recognise what he deems to be a mistake and cut interest rates to 2-3% by year end and that 10-year yields will fall 2.9%. Even if the Fed cuts rates later this year, given long lags between policy choices and inflation outcomes, we could see inflation fall to 2% by end of year. That is basically at Fed target.

If we go back to monetary expansion, central bank largesse will no longer be curtailed, and we can see a strong case for investors holding more gold exposure. In this case we keep positioning in gold futures at 150k net long (only slightly down from today’s level of 170k).

In this scenario, gold rises to US$2135/oz, aided by falling bond yields.

Bull case

This scenario is broadly the same as the Siegel case, with the main difference being the inflation outcome. In this alternate case, the Fed is genuinely convinced by the arguments put forth by Professor Siegel (housing market softer than Consumer Price Index (CPI) methodology calculations, money growth falling fast etc.) and, seeing the visible impact of monetary tightness on the economy, decides to cut rates. However, inflation doesn’t fall as much as they feared because price shocks (for example, another energy crunch or China re-accelerating faster than expected) keep prices of globally traded goods higher. In this scenario, inflation finishes the year higher at 4%. The US dollar softens more than in the consensus scenario as monetary conditions are loose relative to inflationary outcomes.

In this scenario, gold could reach US$2314/oz. Despite piercing the all-time nominal high by 11.5%, it is still shy of the all-time real high by 11% and 2% below the nominal high of 2020 (in real terms).

Bear case

In the bear case, CPI inflation falls to 2.0%, that is, the same as the Seigel case. However, the Fed does not respond in the manner Siegel hopes and maintains a hawkish line. Bond yields and the US dollar reverse course once again and present headwinds for gold in a similar fashion to 2022, but the metal no longer has inflation as a source of support. With investors neither looking for an inflation hedge or worried about central bank largesse, speculative positioning for the metal falls, reaching similar lows to those observed in September 2022.

In this scenario, gold could reach US$1616/oz, retracing prices back to March 2020 levels.

Source: WisdomTree Model Forecasts, Bloomberg Historical Data, data available as of close 31 December 2022. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

 

Consensus

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Inflation forecast

5.6%

3.8%

3.2%

2.9%

Nominal 10-year yields forecast

3.69%

3.65%

3.55%

3.42%

US$ exchange rate forecast (DXY)

104

102

101

99

Speculative positioning forecast

100k

100k

100k

100k

Gold price forecast

US$1970/oz

US$1990/oz

US$2000/oz

US$2080/oz

Source: WisdomTree. Bloomberg Survey of Professional Economists. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

 

Siegel

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Inflation forecast

4.8%

3.5%

2.8%

2.0%

Nominal 10-year yields forecast

3.5%

3.2%

3.0%

2.9%

US$ exchange rate forecast (DXY)

104

102

101

99

Speculative positioning forecast

150k

150k

150k

150k

Gold price forecast

US$1970/oz

US$2020/oz

US$2100/oz

US$2135/oz

Source: WisdomTree. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

 

Bull

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Inflation forecast

6.0%

5.5%

4.5%

4.0%

Nominal 10-year yields forecast

3.5%

3.2%

3.0%

2.9%

US$ exchange rate forecast (DXY)

100

98

96

94

Speculative positioning forecast

150k

150k

150k

150k

Gold price forecast

US$2160/oz

US$2190/oz

US$2240/oz

US$2314/oz

Source: WisdomTree. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

 

Bear

Q1 2023

Q2 2023

Q3 2023

Q4 2023

Inflation forecast

4.8%

3.5%

2.8%

2.0%

Nominal 10-year yields forecast

3.7%

3.9%

4.1%

4.3%

US$ exchange rate forecast (DXY)

104

106

108

110

Speculative positioning forecast

90k

80k

75k

50k

Gold price forecast

US$1910/oz

US$1875/oz

US$1804/oz

US$1616/oz

Source: WisdomTree. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

Real gold prices, even under the bull case, fall short of 2022, 2011, and 1980 levels

Though this repeats the point we started with, it is worth emphasising that, while our forecasts may provide a ‘sticker shock’ to the value of gold by the end of the year (in consensus, Siegel, and bull cases), in real terms the values are not that shocking. That is a story about just how aggressive inflation has been in recent years.

Source: WisdomTree Model Forecasts, Bloomberg Historical Data based on LBMA and Bureau of Labor Statistics data, January 1947 to December 2022. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.

 

Written by Nitesh Shah.

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