29 JUN, 2023
By James Luke, Fund Manager, Metals, Schroders
As we approach the peak of interest rates, we expect gold to continue shining throughout the year. Prices should remain high for the rest of 2023, and we also believe it is highly likely that gold will reach new all-time highs. This could have significant implications for gold stocks, which are usually valued using a lower long-term price, typically around $1,650-1,700 per ounce. With the market increasingly convinced that gold prices can remain high for a longer period, stocks have ample room for revaluation.
Why do we think this way? If a recession looms in the United States, central banks may be forced to loosen monetary policy earlier than in previous cycles and before core inflation is truly under control. This could mean that inflation becomes structurally more entrenched. From our perspective, real interest rates will decrease, which should be positive for gold.
But in the current macroeconomic context, we believe that the key argument in favor of gold should revolve more around the general "normalization" of monetary policy, rather than a very specific relationship between the price of gold and interest rates or the U.S. dollar.
If one believes that the Federal Reserve can achieve a true normalization of monetary policy, then the prospects for gold do not appear particularly bright. By "normalization," we mean a return to a world where normal business cycles are regulated solely by monetary policy, without the need for central banks to resort to quantitative easing (QE) or governments to adopt aggressive fiscal policies to support growth.
All of this seems highly unlikely to us. Policymakers are facing numerous macroeconomic pressures, but what stands out are the current state of U.S. public finances and the very high levels of debt. It is possible that these pressures will lead to a "normal" political response to the next recession being insufficient, and there will be a need to resort to unconventional measures (such as direct debt monetization, resumption of quantitative easing, direct fiscal programs). Such a context could be much more favorable for gold.
From this perspective, gold is somewhat of an indicator of the credibility of these institutions. The lower the credibility of the Federal Reserve and the more extreme the measures taken by policymakers, the stronger the elements in favor of gold become.
It is becoming increasingly evident that the expansion of central bank balance sheets, particularly the Federal Reserve's, is not a temporary measure. If we think back to 2008, we must keep in mind that Ben Bernanke made it explicitly clear that QE and the expansion of bank balance sheets would be temporary measures and would be normalized. We are talking about a whopping $9 trillion. How temporary do we actually believe it is? What do we think would happen to that balance sheet in the event of another recession? What just happened to the balance sheet in May in response to a regional banking crisis? It immediately rose.
There are underlying systemic tensions that make some of these short-term issues a mere pretext, the most recent glaring example being the debt ceiling problem.
In conclusion, if one believes they are on the path to a return to a normalized monetary policy regime, they can also avoid thinking about gold. However, if one is slightly more skeptical, as we are, then gold certainly has a place in our thoughts, as do commodities in general.