Fed pivot? Get ready for a gold & silver breakout
Ned Naylor-Leyland explains how a shift in central bank policy could trigger a change in market sentiment that sends gold and silver prices to record highs.
The price of gold has fallen back after touching near record highs in March and in 2020, and we believe that monetary metal prices are poised to rebound should the US Federal Reserve (Fed) «pivot’’ and ease off its current hawkish path.
The Fed has promised to do whatever it takes to tame inflation – which means open-ended tightening. Inflation in the US has been running above expectations – 9.1% y/y in July – and the market has swiftly priced in more aggressive pace of rate hikes. This has brought about a surge in nominal yields — the US 10-year Treasury yield rose to its highest level in more than a decade in June — as well as a strong dollar and a selloff across many asset classes.
By implication, the Fed is saying that real interest rates, or the interest a bond pays after accounting for inflation, will move from deeply negative today to positive in the future. This has hit gold prices, which move inversely to forward real rates. In the forward market investors still presume that current inflation will disappear and all the promised rate hikes will happen.
Overtightening
It’s an interesting time for monetary metals bulls like me. Should we believe the Fed? Can the rate setters really do what they say they’re going to do? I’m not so sure. Inflation was the biggest worry for markets through the first half of this year, but what’s starting to dominate market discussions now is the data showing slowing economic growth and the potential for a recession. Many economists are pencilling one in.
The worry is that the Fed will overtighten and then have to pivot. A dovish shift by the Fed could be driven by an economic «hard landing’’ or even by data showing further easing of inflation, whereby the Fed says it doesn’t have to raise interest rates anymore.
This is where the value of holding alternative currencies such as gold and silver will come good, in my view. Gold and silver are bets that future real rates are not going to rise as much as the market thinks because the Fed won’t be able to pull it off.
Too painful
The most likely scenario in my view is that economic conditions get sufficiently weak so that continuing to hike rates becomes too painful. This scenario is likely to result in rate expectations dissolving in the yield curve more quickly than inflation expectations.
A hard landing or recession won’t necessarily make inflation go away – think about stagflation. On the other hand, rate hike expectations would disappear pretty quickly, in my opinion. That would be good for gold and silver.
It’s worth noting that the price of gold priced in dollars has declined in part due to the dollar’s strength in foreign exchange markets this year. Gold priced in yen, euros and sterling remains very elevated.
Breaking through
We are back at historic lows of participation in the gold market. That creates the best kind of entry point for investors, in my view. Gold is trading around $1,700/oz and to get to $2,100/oz, as it was in March, it would again be challenging the inflation-adjusted all-time high. I think that gold has a very good chance of breaking through the $2,100/oz record. Records are made to be broken, and dollar strength will not last forever.
The market is motivated by waves of hawkishness and waves of dovishness. Looking ahead, I think the conditions are right for a move back to a more dovish environment and a Fed pivot. That’s why I believe it’s the perfect time for prudent investors to own gold and silver.
Falling real yields mean a higher gold price
Source: Bloomberg, as at 31.05.2022
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Important Information
This document is intended for investment professionals* and is not for the use or benefit of other persons, including retail investors, except in Hong Kong. This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued in the UK by Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A. (JAMI), registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited (JAM HK) and has not been reviewed by the Securities and Futures Commission. No part of this document may be reproduced in any manner without the prior permission of JAM/JAMI/JAM HK.
*In Hong Kong, investment professionals refer to Professional Investors as defined under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).and in Singapore, Institutional Investors as defined under Section 304 of the Securities and Futures Act, Chapter 289 of Singapore. 29231
