Gold Q4 2022 Fundamental Forecast: The Storm May Get Worse Before It Gets Better
- Gold prices plunged during the third quarter after a temporary respite between late July and early August
- Rising bond yields and the strength of the U.S. dollar have been two of the most important bearish drivers for the yellow metal
- XAU/USD is likely to retain a negative outlook in the near-term
Gold suffered heavy losses during the third quarter, extending the decline of the previous three-month period. Although XAU/USD experienced a temporary respite between late July and early August, when bullion briefly rose above $1,800 per troy ounce, sellers soon resurfaced to cap the upside and trigger a brutal bearish reversal, sending prices tumbling below $1,700 towards the end of September, the lowest level in more than two years.
This sell-off was partly triggered by rising borrowing costs across developed markets, but more importantly the United States. Central banks around the world have rapidly withdrawn stimulus in 2022 in their efforts to tame soaring prices. The Federal Reserve, for instance, has tightened monetary policy by 300 basis points in the last seven months, paving the way for sovereign bond rates and for the U.S. dollar to jump to multi-year highs, two headwinds for the yellow metal.
The chart below shows how XAU/USD, which is plotted on an inverted scale for better visualization, has steadily weakened as both the DXY index and the US 10-year TIPS, a proxy for real yields, have roared higher since March, when the FOMC began to reduce accommodation. There is no question that the correlation is tight for all three assets during this period.
Gold Prices, DXY and US 10-Year Yields Chart
Turbulent Waters Await Precious Metals
In general, when the U.S. dollar strengthens, commodities become more expensive in terms of other currencies, a situation that can lower their demand and thus prices in global markets. In addition, when real yields rise, the opportunity costs increase of holding assets that don’t pay interest or dividends, such as precious metals, leading investors to seek better returns elsewhere.
Looking ahead, there is reason to believe that gold could continue to underperform early in the fourth quarter before bottoming out in late fall. The Fed’s increasingly hawkish stance indicates that its benchmark interest rate could peak at 4.6% next year, up from the current 3.1% (midpoint), and its “higher-for-longer pledge” should keep U.S. Treasury yields and the U.S. dollar biased to the upside, creating a hostile environment for precious metal in the near-term. The chart below shows how nominal yields have fared this year with the FOMC’s normalization process at full steam.
U.S. Treasury Bond Yields (Nominal)
Cloudy Skies May Clear Late at Year’s Turn
Gold’s outlook, however, could improve at the turn of the year as tightening financial conditions begin to trickle through the real economy, reinforcing downside risks for both the U.S. and global economy. Monetary policy acts with a long and variable lag, suggesting that the full negative impact of the Fed’s hiking cycle has yet to be felt. When the detrimental effects start to be more apparent before the quarter ends, defensive assets could benefit, bolstered in part by safe-haven flows.
In addition, forward-looking investors and traders will begin to position for a dovish pivot when recessionary headwinds become too strong to ignore, slowly driving down long-term bond yields, which generally reflect growth and inflation expectations for the future. When these events play out, gold prices could stabilize and stage a more durable recovery in the early stages of 2023. In contrast, in the early stages of the fourth quarter, poor fundamentals call for more weakness or, at least, sideways price action in XAU/USD.
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