In 2023, a year characterized as extremely challenging, gold as an asset exceeded most expectations. Amid high interest rates, geopolitical events and an unclear direction of travel from the Federal Reserve's rate-setting committee, gold returned just over 13% on an annualized basis. And as we move into early 2024, several factors that contributed to gold's strong performance last year are once again well-positioned to support demand for the metal and its price performance.
Most investors are speculating whether the Federal Reserve could achieve a so-called “soft tapering” in 2024, and that remains the main factor that advisers weigh as they look to maintain or adjust their allocation to gold. Looking back over the past two decades, portfolios that include some gold investments have likely outperformed an equivalent portfolio that did not invest in gold.
While other influences will affect gold's performance going forward, the Federal Reserve's decision-making will play a key role. Last year, market watchers backed away from predictions that the Federal Reserve would continue to raise interest rates to tame inflation. As the year progressed, leading indicators signaled that the Fed's rate policy was having its intended impact and that inflation was falling. Today we find that the Fed has put a hold on any further rate hikes, with its last hike due in July 2023.
Investors may believe that higher interest rates tend to make assets that generate yield without having to be sold, such as bonds, relatively more attractive than the precious metal. But because there is no risk of default (ie, no credit risk), gold's yield comes in the form of price appreciation, not coupons or cash flows. The current “pause” in interest rate hikes – and the potential for cuts – could increase gold's attractiveness relative to assets such as bonds, which have benefited from the recent high-rate environment.
As we look ahead to 2024, all eyes remain on the Fed and whether Jerome Powell can navigate the economy to a manageable outcome. And that remains a big “if” – wage growth is strong and if consumer prices remain stubbornly high, this could lead to interest rate cuts later in 2024 than previously expected. Indeed, there is a wide range among rate forecasters on how much the central bank might loosen its rate-cutting policies this year. If the economy heads into a recession, the Fed may accelerate its consideration of rate cuts. Consumer spending could fall in this scenario, which could affect certain areas of demand for gold products, such as jewelry. However, demand among some of the largest gold market participants – investors and central banks – in a lower interest rate environment will see “investment and savings” demand for gold increase.
We have laid three simple scenarios that will help investors better navigate the broader economic landscape by understanding the impact it will have on gold's performance.
Soft landing: The market consensus is that this is still the most likely scenario to play out. The US economy continues to show resilience, unemployment levels are modest and US-based companies have reported strong fundamental metrics. This would lead to Fed tapering at some point in 2024 (as estimated by CME FedWatch tool), and our view is that cuts of 75-100 basis points could benefit gold as this is often associated with increased demand.
Hard landing: However, if the economy experiences a more severe “hard landing,” the Fed will have no choice but to move quickly with even steeper cuts, correlating with the potential for even higher demand for gold. As the recession puts downward pressure on consumer demand for retail (such as jewellery), central bank and investment demand would be higher and this overall outlook would be positive for gold anyway.
No discounts: This scenario – where we are today – presents the most challenging environment for investors to navigate, and its gray area leaves the potential for a sudden spike in inflation. This could leave us with “more of the same” from the Federal Reserve if it pushes the can further on rate cuts, and as a result a longer runway before we see actions that add upward pressure on gold prices. While there is no immediate clarity on the timing of rate cuts, expectations of cuts have led to a December 2023 boom and gold to all-time highs. These expectations have softened again, and expectations for cuts have shifted later to 2024. All of this begs the question: will we see this challenging environment last longer and longer?
While all of these primary scenarios specifically address the US economic landscape, we should not overlook the fact that there is more to gold than can be illuminated by just one factor. Gold is a global asset and its diverse sources of demand set it apart. The potential for future, unexpected geopolitical, political and financial risks – both domestic and foreign – is widespread and can have a significant impact on interest in the gold market and, more importantly, its performance.
Advisors should avoid falling into the trap of focusing too much on one specific driver of gold's performance. Looking ahead to 2024, there are still key factors that could impact gold demand, including geopolitical turmoil, political elections on an unprecedented scale and a general risk environment driving many global capital groups (or through the Central Bank's reserve portfolio or investment portfolios) to gold.
Joe Cavatoni is Senior Market Strategist, Americas, World Gold Council