The gold price has been pulled by two opposite forces over the past few months; geopolitical risks and inflation vs higher interest rates and a firmer US dollar.

At the start of the year the gold price increased due to the geopolitical risks that arose from the conflict in Ukraine. Gold is a safe haven asset and in times of stress provides investors safety, which is exactly what occurred during the first quarter. Gold pushed higher as investors gravitated to more safe haven type assets.

As we moved into the second quarter however, two major financial indicators appear to be involved in the fall in gold prices. Firstly, as investors began focusing on the impact that higher inflation would have on global interest rates, Central banks moved from being extremely dovish to being hawkish and expressed their willingness to combat higher inflation by raising interest rates.

As the Fed Funds rate increased in the US, the US Dollar strengthened. Gold is usually priced in US Dollars and this therefore makes it more expensive in other currencies, and reduces demand, so we have witnessed a reassertion of the traditional inverse relationship between the US Dollar and Gold price.

Higher interest rates are a headwind to gold as it does not provide a yield. The increase in interest rates leads to higher yields on fixed income assets, which can lead to investors favouring bonds over gold due to the income on offer.

Secondly, as gold is considered to be both a currency and a commodity, the recent industrial commodity weakness has been closely associated with the change in gold prices. There has been a tight correlation between moves in crude oil and gold over the past few weeks, but other metals have fallen hard too, with copper prices at lows not seen since late 2020.

Gold has been further impacted by investor views on commodities in general. Recent investment flows into gold have been weak. COMEX gold futures fell in July and net long futures into the asset were at their lowest level for three years.

So overall for the first half of the year, the gold price ended up flat after its positive start to the year. Gold performed as the team expected it to in both quarters and held up very well against large headwinds for the asset class.

What are investors focusing on which will impact gold moving forward?

We believe that the short-term prospects for gold will very much be driven by the same underlying causes that have been prevalent so far this year. Volatility in markets will continue to be heightened due to political risks, the impact of central bank policy and the risks of the global economy falling into recession. These factors should be positive for the outlook for gold. On the other hand, if central banks continue to increase interest rates and the US dollar stays stronger, this could be a headwind for the gold price.

US economic expectations have shifted from worries about inflation, towards growing fears of recession. This has led to many managers reshuffling their portfolio positioning. Broad-based commodity index selling has occurred, with investors cutting exposure across all commodities, not just gold. However, we believe that over time gold will provide a ballast for investors in poorer economic conditions, and so this correlation should reduce.

As the US Federal Reserve is acting more aggressively than other major central banks, this is supporting the dollar and keeping it high due to the increasing expected and realised interest rate differentials. Finally, momentum in gold has played a role. It is likely that speculative traders who play gold in the short term were watching US$1800/oz as a key level and, when this gave way, they were quick to cut longs or add to shorts. Seasonally, gold is often weak in the summer, and this has added to trader’s negativity on gold. Once the short sellers have been priced out, the gold price should restabilise and be positively impacted again by flows into the asset due to declines in the global economy.

We believe the medium to long term is where gold will provide the best opportunities. The headwinds of higher interest rates and a firm US dollar currently look like they will start to diminish as we move into next year. Markets are pricing in that central banks will raise rates for the next few months, and then stop and may potentially even cut rates moving through 2023. This is due to the increasing risk that a recession may occur. If this occurs the gold price should perform positively due to the following reasons:

• Being a safe haven asset, it should perform well in volatile markets, where other assets may be under pressure
• Once yields have peaked, the nominal yield on bonds will become less appealing for investors and so gold should provide a better real return.
• If central banks do start cutting rates because a recession is looking likely, but inflation stays slightly higher, gold should work well as it does not provide any yield and so the real return will be higher.
• Finally, other investors will likely move into the asset class to provide further diversification due to its underlying characteristics as risks continue to increase.

Gold has been an allocation within the portfolios for some time to act as a diversifier within our alternative’s allocation. In the lower risk portfolios, we hold gold bullion ETFs and in the higher risk portfolios we invest in gold & silver miners. The difference between the two is that gold bullion ETFs track the underlying gold price and hold the bullion directly. Gold miners invest in the shares of mining companies, and these generally have a higher beta to the gold price and so are more volatile but can provide greater return opportunities when the outlook for gold is positive. Whilst both are impacted by the above comments, we detail below a few additional considerations with regard to gold miners.

Gold Miners

The returns of gold miners over the past few months have been volatile to say the least. They have moved in line with the gold price but also have been impacted by other factors including investors preference for mining stocks, its correlation to other commodities and the growth vs value paradigm.

The Ukraine war did not positively impact the price of gold mining assets as quickly as they did for gold bullion. The stocks came under pressure with all equities as investors sold down across the board on the news of the invasion. However, investors started to reprice the impact that the war would have on commodities and the increase in the gold price due to its haven status moving through the first quarter.

This led to gold miners providing a positive return by the end of Q1. This continued for the first few weeks of April and May with miners performing positively once again. However, this performance fell away as we moved through Q2. This was further exacerbated in June by a falling gold price and the worries that a global recession will provide headwinds to commodities and global miners especially. If demand for commodities does fall after it has been strong for the past few years, this would impact global miners.

Gold miners were also caught up in the selling of more value style stocks in June, as the recession risk increased. Investors were profit taking in names that had performed well and were looking to be more defensively positioned moving into the second half of the year, removing many value names they were holding previously. This included commodity companies and global miners, which led to negative performance in our gold mining holdings to the end of July.

Moving forward we believe that the opportunity for gold miners is extremely positive, and even more so after the performance of the past few months. Many miners are valued cheaply and have positive fundamentals. These include lower capex spend over the past few years; increased efficiency and falling demand. This should drive prices moving forward. This is extremely positive for investors who have a longer-term view and can look through the short-term noise to what will drive returns for the future.