The macro backdrop remains challenging with investors switching between stagflation concerns and reflation hope. Inflation remains elevated with mixed growth data. Fears that the energy crunch and supply chain problems could lead to stagflation — low economic growth along with high inflation — buoyed gold’s appeal as an inflation hedge. Yet the S&P500 hit an all-time high, helped by another strong earnings season.
Bond markets have pulled forward rate hikes very sharply in the past few weeks, but do not see the hiking cycle persisting, and may even consider it a policy mistake. This is also why US long-end rates are still below March highs.
Expectations of slow growth over the medium-to-longer term kept 10-year US real rates pinned down despite the move higher in nominal yields. This has allowed gold to make a modest comeback, pushing prices briefly above USD1800/ounce. Temporary rallies are possible if stagflation concerns worsen but USD1840/oz should serve as a soft cap.
Recent Upside Inflation and Downside Growth Surprises Have Heightened Stagflation Concerns
Source: Citi, Bloomberg, Bank of Singapore
We continue to think that gold should settle lower – we do not think recent macro developments of global inflation surprising on the high-side while growth surprising on the downside are sufficient to alter our core view. Supply shocks from rising energy prices that boost inflation and damp growth tend to trigger stagflation fears of the 1970s. But we think this fear is misplaced given the modest size of the energy shock and the strong fundamentals supporting resilient growth.
We target gold at USD1620/oz in a year’s time for several reasons. First, stagflation is a tail risk but not the base case. Stagflation concerns should give way to at least a combination of slower inflation and stable but still-strong growth in 2022, which would diminish gold’s appeal.
A moderation of inflation is likely as manufacturing supply bottlenecks abate and as growing oil supply see energy prices decline after winter. As the Delta scare recedes, US labour supply could improve to support an acceleration in services output. This in turn could encourage 10-year US Treasury yields to rise to 1.90% in a year’s time -- but led more by real yields rather than higher breakevens.
Second, the Fed’s hawkish tilt is set to hasten USD’s transition onto a stronger path over the medium term. While not a “King Dollar” environment, moderate USD strength is set to weigh on gold.
Third, growing investors’ interest in bitcoin as an inflation hedge could trigger further shift from gold ETFs into bitcoin funds. Bitcoin’s allure as an inflation hedge has been reinforced by soaring prices -- significantly outpacing the modest comeback in gold prices since end September –leading up to the launch of the first bitcoin ETF in the US.
Risks Skewed Toward Higher US Real Yields
Source: Bloomberg, Bank of Singapore
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