Gold Market Commentary | Potential Volatility in Q4

September Review:

Gold prices fell 3.7% in September, with most of the decline occurring in the last three days of the month.

We believe the challenges to gold's performance in September stemmed from a sharp rise in bond yields and a strengthening US dollar; the end-of-month sell-off may have been due to strong US economic data and sell-offs triggered by a technical breakdown in gold prices.

Future Outlook:

Gold may face continued volatility in the future as bond yields remain elevated and the US economy remains strong.

However, we believe that gold will not experience a substantial downward trend, as a fragile stock market, rising recession risks, volatile inflation, and continued central bank interest in gold will continue to provide support; if the market is excessively short, this may be a buying opportunity for some investors.

End-of-Month Decline

For most of September, gold prices hovered in the range of $1,900-1,950 per ounce until a sharp drop on the 27th, closing the month at $1,871 per ounce, a 3.7% decline from the previous month. Due to the strengthening US dollar, the month-on-month decline in gold prices in euros, yen, and pounds in September was smaller (Table 1).

Table 1: Gold prices fell across the board, but European, Japanese, and UK gold prices fell less due to weaker currencies

Gold prices and returns in major currencies over different periods*

*As of September 29, 2023. Calculations are based on the LBMA gold price at noon, priced in the above currencies.

Source: Bloomberg, ICE Benchmark Administration, World Gold Council

Our short-term gold price performance attribution model (GRAM)[1] shows that the main reason for the decline in gold prices was the increase in opportunity cost, as the US 10-year Treasury yield rose by nearly 50 basis points in September; secondly, the strengthening US dollar (DXY US dollar index rose 2.5%) was also a contributing factor to the decline in gold prices. However, the GRAM model shows that when analyzed on a weekly basis (not shown here), opportunity cost is not sufficient to explain the end-of-month decline in gold prices. We believe several factors are at play: First, investors overreacted to the strong data on US capital and durable goods released on September 27[2]. In addition, we cannot rule out the possibility that stop-loss orders were triggered by gold prices breaking below $1900 per ounce, and there was also a crossover of its short-term and long-term moving averages, which is usually considered a signal of a trend change (Figure 1).

In September, global gold ETFs continued to see outflows of approximately $3 billion (-59 tonnes), mainly driven by North American and European funds; net long positions in gold futures managed by funds on the New York Mercantile Exchange (COMEX) decreased by approximately $4 billion (70 tonnes).

Figure 1: Rising interest rates and a stronger dollar combined to cause gold prices to fall in September*

*Data as of September 29, 2023. Our short-term gold price performance attribution model (GRAM) is a multiple regression model of monthly gold returns, including four key gold price performance drivers: economic expansion, risk and uncertainty, opportunity cost, and momentum. The related themes of these drivers reflect the motivations behind gold demand, and more importantly, the motivations behind investment demand. These are considered marginal drivers of gold price returns in the short term. "Residuals" include other factors not yet captured by the current model. The results here are based on analysis from February 2007 to September 2023.

Source: Bloomberg, World Gold Council

Future Outlook

Bond yields continue to surge due to the firm stance of global central banks, led by the Federal Reserve, on keeping interest rates higher for longer, coupled with an oversupply.

Meanwhile, US economic fundamentals remain strong, and a soft landing remains the consensus outcome.

The dual factors of economic resilience and rising yields could create volatility in the gold market.

However, we believe that gold is more likely to experience volatility rather than a substantial weakening, as there are still many supporting factors: lower equity risk premiums, higher recession risks in the next 6-12 months, volatile inflation, and central bank gold purchases.

Secondly, the opportunity for short covering should not be ignored, as current net short positions in COMEX gold are at their highest since March, and gold ETFs are also experiencing significant outflows.

Treasury-led bond yields are rising. The US 10-year TIPS yield, historically closely correlated with gold, has broken above 2.3% for the first time in 15 years[3]. This factor, coupled with the strengthening dollar[4], has historically proven to be quite challenging for gold (Figure 2).

Figure 2: Real yields may start to be affected*

*Monthly returns are calculated based on the average gold return (LBMA noon price) within the following historical real yield ranges: US 10-year TIPS yield, US 1-year Treasury yield minus Michigan 1-year expected inflation, and US 5-year Treasury yield minus Michigan 5-year expected inflation. The results here are based on analysis from December 1971 to December 2022. The latest TIPS yield is as of November 30, 2023.

Source: Bloomberg, World Gold Council

While the rise in yields in August may have been driven by both supply and demand and economic fundamentals, monetary policy may be returning as the dominant factor, and in recent weeks, monetary policy has remained firmly hawkish (Chart 1).

Figure 3: Oversupply and hawkish policy statements push US Treasury yields higher

21-day rolling correlation between December 2024 Fed Funds futures and US Treasury yields.

Source: Wanda Research

Double-Edged Sword

But gold is not the only asset affected by the surge in bond yields. Higher yields depress equity risk premiums, coupled with optimistic profit growth forecasts (Figure 3), which is reminiscent of the situation at the end of 2007; and further tightening of yields has tightened financial conditions, somewhat similar to 2007 (Figure 4). This situation may exacerbate recession risks in the next 6-12 months.

Figure 4: The stock market remains fragile, similar to the situation at the end of 2007*

Equity risk premium calculation based on the inverse of the 12-month forward P/E ratio minus the US 10-year Treasury yield.

Source: Factset, Macrobond, World Gold Council

Figure 5: Concerning Financial Conditions*

*Tightening lending standards: Average for small, medium, and large enterprises. The financial conditions pulse measures the expected impact of tighter financial conditions on the economy.

Source: Bloomberg, World Gold Council

Higher yields may reflect inflation volatility [5]. Inflation trends may be downward, but volatility is also possible. In the US market, the following factors need to be considered:

In addition to the overall Consumer Price Index (CPI), other inflation indicators also rose in August [6].

Used car prices have risen again, and the long-term strike by the auto industry union is a concern [7].

Healthcare service costs, which have generally declined month by month over the past year, have rebounded and are expected to increase again [8].

Oil prices have climbed to $100 a barrel and appear easily susceptible to geopolitical factors; supply issues persist, while demand is 2% higher than before the COVID-19 pandemic [9].

Both high inflation and inflation volatility are very challenging. This is an economic problem, but it has historically also been a problem for the stock market.

Figure 6: Rising oil and healthcare prices are concerning*

Brent Crude Oil (USD/bbl), seasonally adjusted US Healthcare monthly data