Despite potential rate hikes, real rates remain low
Gold may face similar dynamics in 2022 to those of last year, as competing forces support and curtail its performance. Near term, the gold price will likely react to real rates in response to the speed at which global central banks tighten monetary policy and their effectiveness in controlling inflation.
Yet, in our view:
· while rate hikes can create headwinds for gold, history shows their effect may be limited
· at the same time, elevated inflation and market pullbacks will likely sustain demand for gold as a hedge
· jewellery and central bank gold demand may provide additional longer-term support
Higher rates in 2021 outweighed inflation risks
Gold finished the year approximately 4% lower, closing at US$1,806/oz.[1] The gold price rallied into year-end on the heels of the rapidly spreading Omicron variant, likely prompting flight-to-quality flows, but it was not enough to offset H1 weakness.
Early in 2021, as newly developed vaccines were rolled out, investor optimism likely fuelled a reduction in portfolio hedges. This negatively impacted gold’s performance and resulted in gold ETF outflows. The rest of the year was a tug of war between competing forces. Uncertainty surrounding new variants, combined with increasing risks of persistently high inflation and a rebound in gold consumer demand, pushed gold forward. Conversely, rising interest rates and a stronger US dollar continued to create headwinds. However, dollar strength led to positive gold returns in some local currency terms, such as the euro and yen among others (Table 1).
Our gold return attribution model corroborates this. Rising opportunity costs were one of the most important contributors to gold’s negative performance in Q1, and intermittently in H2, while rising risks – especially those linked to elevated inflation – pushed gold higher towards the end of the year (Chart 1).
Chart 1: Rates and inflation were two the most important contributors to gold’s performance in 2021
Contributions of gold price drivers to periodic gold returns*
*As of 31 December 2021. Our short-term model is a multiple regression model of monthly gold price returns (based on XAU), which we group into the four key thematic driver categories of gold’s performance: economic expansion, market risk, opportunity cost, and momentum. These themes capture motives behind gold demand; most saliently, investment demand, which is considered the marginal driver of gold price returns in the short run. ‘Unexplained’ represents the percentage change in the gold price that is not explained by factors currently included in the model. Results shown here are based on analysis covering an estimation period from February 2007 to December 2021. On Goldhub, see: Short-term gold price drivers.
On Goldhub, see: Short-term gold price drivers
Table 1: Gold’s price performance was mixed across currencies
Gold price and annual return in key currencies*
Source: Bloomberg, ICE Benchmark Administration, World Gold Council
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References:
[1] Based on the LBMA Gold Price PM as of 30 December 2021. It should be noted that while a closing price for the LBMA Gold Price PM is not available for 31 December, gold rallied that day. Based on XAU – a commonly used proxy for spot gold price – gold finished slightly higher and up 3% in December.