The primary drivers of gold
As gold is a good hedge against uncertainty, geopolitical turmoil will be the primary driver of prices in the short-term. The consequences of the various crises are likely to support the market in the second half of 2022 as indicators suggest higher inflation and slowing growth. Although much economic data indicate expansion, things could turn swiftly. The US yield curve is flattening, suggesting expectations of a slower growth. The macro backdrop looks challenging with central banks finding it difficult to set policy for the second half of 2022. Market volatility is likely to remain elevated which should see them building strategic positions.
So how long can these geopolitical events sustain higher gold prices? Previous geopolitical events suggest such crises have a fleeting impact and gold quickly sheds its safe haven gains once the event subsides. Geopolitical risk does not trigger long-term monetary policy adjustments. The most recent similar event was the invasion of Crimea in February 2014 which saw gold rise from $US1,220 per ounce to $US1,382 per ounce on 14 March. But those gains were quickly lost with prices falling 7 per cent in the next 14 days and 10 per cent over the following three months. However, should the current geopolitical crisis trigger an economic slowdown and then monetary policy changes, this time could see prices lift for longer.
It is worth noting this geopolitical crisis is different in some ways. In fact, it’s a relatively bigger set of crises than any since World War II and is coinciding with a particular phase of the business cycle. Inflation is rising rapidly while conflicts and the pandemic have caused commodity supply shocks that could keep pressure on real rates. Prior to the pandemic, these rates had fallen very close to record lows, creating a supportive backdrop for gold. Also, Russia is a major producer of gold so current sanctions will impact supply - although ANZ Research expects the impact to be minimal. Central bank purchases could increase overall as Russia’s central bank buys gold from its domestic producers.
The US angle
Theory suggests rising interest rates from the US Fed make bonds and other fixed-income investments more attractive, pushing investors into higher-yielding investments such as bonds and money market funds. Rate hikes also coincide with economic growth cycles which encourage investment in risky rather than safe haven assets.
So does this mean gold remains a good hedge against inflation in the current scenario? When gold backed the US dollar, it was a hedge against inflation and a way of protecting investor purchasing power during high inflation periods. Today, its impact is weaker and linked more to inflation expectations than to the actual inflation rate. Investor demand for gold has been rising since Russia invaded Ukraine, which is linked to both inflation expectations and haven demand. Should the Fed move aggressively to contain inflation, we could see consequences for the gold market.
Normally, the US dollar is inversely related to gold - a stronger dollar lowers gold prices. However, this relationship can weaken during crises, during which both gold and the US dollar can rise. This was evident during the Global Financial Crisis in 2008 and at the start of the COVID-19 pandemic in 2020. As geopolitics will be a dominant factor this year, gold and the US dollar could move together in the short-term before resuming their normal relationship.
Along with the G7, the US has announced sanctions on Russia, banning individuals from dealing with the CBR’s international reserves of gold. Violation of this would draw secondary sanctions on people who trade with Russian gold. This aims to prevent Russia from buying and selling gold. Russia holds 2,300 tonnes of gold, 21 per cent of its total reserve. Sanctions will prevent Russia’s gold from flowing through markets elsewhere but it could still find its way into Asian markets. However, ANZ Research doesn’t see this making any material impact to the gold market overall.
Daniel Hynes is Senior Commodity Strategist and Soni Kumari is Commodity Strategist at ANZ