The inflationary shock of 2021 and 2022 was followed by very aggressive interest rate hikes that weighted on the price of gold. With the end of the rate hiking cycle, we analyze what will happen to the price of gold in 2023.
- Interest Rates
- Strength of the US Dollar
- Geopolitical Tensions
- Gold Reserves vs. US Dollar Reserves
The years 2021 and 2022 saw the highest inflation rates since the 1980s in most Western economies. After more than a decade of low inflation, many developed countries experienced inflation rates close to and even above 10%.
This led to a deep cost of living crisis in many regions as salaries and wages failed to keep up with inflation. In fact, this translates into a lower standard of living for a great portion of the population.
In response to this inflationary shock, most central banks reacted by increasing interest rates in a very rapid and aggressive for way. For example, the US Federal Reserve Bank went from 0% interest rates to about 5% in less than 12 months. And other major central banks, including the ECB, BOE, SNB and those of most emerging countries, followed suit.
Higher interest rates led to a crash in the bond market. All of a sudden, bonds that were trading at very low interest rates had to be repriced to offer much higher yields. Such an adjustment came in the form of lower bond prices, especially for long duration bonds.
Falling bond prices weighted on other asset classes including stocks and gold. This is because, for the first time in more than a decade, bonds started to look like an attractive place to invest for the long term.
And even though the price of gold performed relatively well by comparison in 2022, it failed to rally in the midst of a great inflation shock.
In this post, we analyze how the most important macroeconomic and geopolitical factors could affect the price of gold in 2023. Depending on what happens over the next few months, the price of gold could skyrocket in 2023:
As we have just discussed, 2022 began with interest rates at 0% in the United States and the United Kingdom, and negative rates in most European countries and Japan. However, that year ended with rates having moved up by over 500 basis points in some of these jurisdictions.
We can highlight the Federal Reserve Bank moving from 0% to 5%, the European Central Bank moving from negative to close to 4%, and the Bank of Japan changed monetary policy for the first time in decades.
In smaller economies, such as the United Kingdom, Brazil, Canada, Australia, Switzerland and Norway, interest rates have also risen dramatically.
These hikes have caused interest rates on government bonds to rise, making these safe bonds more appealing to investors. Because gold and government bonds compete with each other, the higher yields on treasury bonds made it impossible for gold to rally in 2022.
If inflationary pressures ease in 2023, regardless of whether there is a recession or not, interest rate hikes will end. It is even possible for interest rates to moderate slightly. Either of these scenarios should be bullish for the price of gold in 2023.
Strength of the US Dollar
The strength of the US Dollar in 2022 led to lower gold prices. However, such statement is only true if we refer to the price of gold in US Dollars, as it is normally quoted in financial markets.
If we look at the price of gold in Euros, British Pounds or Japanese Yen, we will see that gold has been reaching all-time highs for most investors whose domestic currency is not the dollar.
The strength of the US Dollar relative to other fiat currencies and the price of gold in US Dollars are negatively correlated. The stronger the dollar gets, the lower gold tends to go.
If the dollar weakens significantly in 2023, perhaps due to a recession in the United States that leads to lower interest rates, we could experience a rally in the price of gold.
Inflation is probably the most important and unpredictable macroeconomic variable of 2023. Investment professionals are divided about their outlook for inflation in the future. Some of them expect inflation to stay near 10%, while others predict a heavy recession with a deflationary shock.
The important thing to assess how inflation will affect gold prices is to look at real interest rates. Real interest rates measure the difference between nominal interest rates and inflation.
If inflation remains higher than interest rates, real interest rates will be negative which should be positive for the price of gold.
However, if inflation moderates significantly and interest rates remain relatively high, potentially leading to positive real rates in the economy, the price of gold could suffer in 2023.
Another variable that could affect the price of gold in 2023 is the existing geopolitical tensions. The world seems to find itself in a cold war 2.0.
One bloc is composed of the United States, Western Europe and their allies. The other bloc includes Russia, China and their allies. Obviously, there are many countries that remain neutral, thereby setting themselves to benefit the most from this geopolitical fragmentation, such as India, Brazil and the Middle East.
Rising geopolitical tensions, including trade sanctions, embargoes, and heavier measures could contribute to higher gold price in 2023, as demand for safe haven assets increases.
Gold Reserves vs. US Dollar Reserves
Finally, the sanctions that were imposed on Russia in 2022 served as a warning sign for many countries outside of the Western world. Russia saw its US Dollar and Euro reserves effectively confiscated overnight.
This has led many countries to question the appropriateness of keeping a large percentage of their reserves in those currencies. After all, the future is unpredictable and the risk of ending up in a diplomatic conflict with the West can never be ruled out.
Officials in these countries would not want to see most of their foreign reserves disappear because of factor outside of their control. Consequently, many countries are choosing to increase the percentage of reserves they hold in physical gold, divesting from other assets such as US Treasuries.
By holding a greater amount of gold and even using it to settle trade balances, these countries will be less exposed to potential sanctions aimed at weakening their economy and geopolitical interests.
Many central banks bought gold aggressively in 2022. That trend continued in early 2023, giving a boost to the price of gold.
It is very likely that 2023 will see a lot of volatility in the financial markets and the wider world. There are many questions signs about the future of the global economy and diplomatic relations between the most important geopolitical blocs.
In this post, we have tried to analyze how those variables could influence the price of gold in 2023.
While it is impossible to predict the future, it is possible to think about what is happening in the world and how such events can affect us personally and the financial markets.
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