Head of Commodity Strategy
Summary: Gold is once again challenging key resistance above $2000 with a break potentially setting up another strong end of year finish, like what both gold and silver saw during the past six years when December ‘Santa’ rallies yielded an average return in gold of 4% and 7.25% in silver. Both metals have thrived during the past month on rising speculation the Federal Reserve has reached the end of the road of its aggressive rate hike regime, and that next year could see a reversal. While we believe the timing of the first rate will be the next major trigger, we may still see a break above $2010 resistance trigger a FOMO (fear of missing out) move higher, potentially supporting a seventh consecutive December of precious metal gains.
Gold is once again challenging key resistance above $2000 with a break potentially setting up another strong end of year finish, like what both gold and silver saw during the past six years when December ‘Santa’ rallies yielded an average return in gold of 4% and 7.25% in silver. Both metals have thrived during the past month on rising speculation the Federal Reserve has reached the end of the road of its aggressive rate hike regime, and that next year could see a reversal, with a full percent rate cut currently priced in next year with the swaps market seeing the first 25 basis points cut no later than June.
On the macro-economic front, a variety of recent economic data from key economies around the world has strengthened our long-held view that aggressive policy-tightening cycles from the Federal Reserve and other central banks have ended, with the focus now turning to the timing, as well as the pace, of future rate cuts. However, we also acknowledge that central bankers cannot express this (rate cut) view in public as they would risk boosting risk sentiment to the point it loosens financial conditions too soon. A predicament that was on clear display recently when Federal Reserve chair Jerome Powell was forced to dial back the dovish reprising seen following the November 1 FOMC (Federal Open Market Committee) meeting, when Powell strongly hinted that the Fed is done hiking rates.
Financial markets have responded to these recent developments by sending US long-end Treasury yields sharply lower. The dollar meanwhile has suffered a broad retreat, with the Bloomberg Dollar Index currently hovering near a three-month low, while global equity markets have risen strongly, with the S&P 500 currently showing an 18% year-to-date gain. Recently we have also noticed some renewed interest in beaten down sectors that have struggled amid elevated levels of debt and an increasing cost of servicing that debt. Examples of sectors benefiting has been those related to the renewable energy sector that supports demand for metals such as recently beaten down and under owned silver and platinum.
Our gold monitor shows how the recent robust performance has left gold prices a bit elevated compared with the corresponding but still supportive moves in dollar and yields, while the cost of carry as seen through a slightly lower yield on 12-month US treasury bills has started to come down. We believe the risk/reward increasingly favours gold, and that the best is yet to come, but for that to happen investors need a stronger conviction on Fed rate cuts in order to attract fresh demand from investors, including long-only asset managers who have been net sellers of ETF’s for months amid the mentioned high cost of carry.
Total ETF holdings have stabilised during the past month but overall, this year has despite the near 10% gain in spot gold seen a 220 tons reduction, and while a reduction of this size should normally weigh on prices, another source of demand still is extraordinarily strong. In 2022 central banks bought a record 1,136 tons according to the World Gold Council, and with another 800 tons bought in the first three quarters of 2023, this year could potentially end seeing another back-to-back record. Central bank buying has basically put a soft floor under the gold market which has prevented prices from responding negatively to periods of dollar strength and especially rising real yields.
As mentioned at the top, gold has seen a strong December performance during the past six years with the performance ranging from 2.2% in 2017 and 6.8% in 2020 when silver surged 16.6% higher. The December rally in 2020 was driven by the discovery of the Covid-19 vaccine which lifted the prospect for reopening leading to surging inflation following months of government handouts and central bank rate cuts. While we believe the timing of the first rate will be the next major trigger, we may still see a break above $2010 resistance trigger a FOMO (fear of missing out) move higher, potentially supporting a seventh consecutive December of precious metal gains.
Gold mining stocks are in our opinion undervalued on a relative and absolute basis, with the underperformance seen this year between spot gold (+9.8%) and the Vaneck Gold Miners UCITS ETF(+1.5%) being down to several factors. The most important being miners struggling to control costs towards labor, fuel, materials during a time when rising interest rates and inflation has added to the overall cost of funding and running a business. Also, increased ESG (Environmental, Social, and corporate Governance) scrutiny by investors, rising regulatory costs and government intervention have also been weighing.
In addition, with traders and investors so far having struggled to see gold break above $2000, each rally towards this area has triggered profit taking in the mining stocks. We see the prospect for lower funding costs next year as well as gold breaking higher as reasons for the mining sector ‘catching’ up. We like the miners as they provide 1) leverage to the gold price, 2) the prospect for rising dividend yields, and 3) current attractive valuations compared to the price of gold.
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