Gold Outlook for Mar-23 by Chirag Mehta, CIO & Ghazal Jain, Fund Manager, Quantum AMC

Monthly Gold Outlook : March 23

After a close to 6% jump in January, spurred by market optimism about US inflation slowing down and the Federal Reserve turning dovish, gold gave up ~5% in February ending the month close to $1810 per ounce levels, with hawkish repricing of US monetary policy to blame. Correction in domestic gold prices was limited to ~3% in the month aided by a depreciating rupee.

The US economy added 5,00,000+ jobs in January, up from 2,33,000 in December and almost three times what was expected. The unemployment rate in January fell to a 53-year low of 3.4%. Average hourly earnings rose 0.3%; up 4.4% year-on-year.

The inflation report was mixed. While the annual consumer price index inched down to 6.4% thanks to the base effect, prices actually rose 0.5% month on month in January, the most in three months. The Fed’s preferred inflation gauge - the Personal Consumption Expenditure Index too marginally accelerated to a 5.4% annual rate compared to 5.3% in December.

US month-on-month retail sales surged 3% in January, which was the largest increase since March 2021 and well above expectations of 1.8%. The University of Michigan Consumer Sentiment Index improved to a 13-month high in February.

Manufacturing and Service sector activity in the US as indicated by the S&P Global flash US Composite PMI Index rebounded in February after seven months of being below the 50-mark.

The stronger than expected economic reports hinted the US economy is resilient enough to sustain more hikes and changed market expectations of the Federal Reserves’ rate trajectory. Hawkish comments from a string of policymakers and minutes from the February FOMC meeting also reinforced concerns of higher rates for longer. The markets now see the Fed’s terminal rate at 5.25-5.50% up from 5.00-5.25% at the start of the month which implies three additional 25 basis point hikes in each of the upcoming meetings in March, May and June. As a result, the Dollar Index moved from below 102 at the start of the month to 105 levels and US 10-year Treasury yields saw a sharp up move of ~45 basis points ending the month close to 3.95% taking a toll on gold.

The prospect of higher rates is also weighing on stocks and bonds as risks of the Fed reacting to recent data and overtightening have increased, which in turn increases the downside risks for risk assets and the portfolio relevance of gold.

While a recession is not an immediate concern, expectations of a deep downturn in the second half of the year are very much on the table as the lagged effects of the most aggressive Fed tightening in decades show up. The US economy has entered a recession within 6-18 months of the 2year-10year US yield curve inversion each time since the 1980s. The current inversion has been in place since July 2022 which makes a recession hitting in 2HCY2023 or 2024 very likely. Also, since 1970, US housing recessions have a 100% success rate in predicting economic recessions. With the current 20% correction in US residential markets, there is a high probability of a US recession within the next year based on this historical evidence. If the Fed continues to tighten in the run-up to it, a hard landing for the economy is also highly probable.

The pivot narrative may have lost traction for now, but the Fed’s hawkish stance will get tested as and when the economy meaningfully falters. An end to the tightening cycle by mid-2023 and a pivot by the end of 2023 or 2024 in response to the growth setback is thus being priced in by markets as imminent and will be bullish for gold prices as the dollar and yields retreat.

In the meantime, the Fed's hawkish stance should support the greenback by keeping nominal and real rates biased to the upside, even more in case there are any further economic data surprises. This will create headwinds for gold as it heads into March, providing opportunities for incremental investment in gold. Prices can be expected to stay rangebound at these levels as markets react to another payrolls report and two inflation reports before the next FOMC meeting which could again either accelerate or decelerate the pivot narrative.

With US-China tensions recently ignited over the shooting down of an alleged Chinese spy balloon by the US and the Russia-Ukraine war completing a year with renewed support pledges from NATO allies, the geopolitical situation remains supportive of gold. Central bank gold buying which touched a record 1,136 tonnes last year is expected to continue for the foreseeable future, even if the pace does slow from 2022 levels, providing a soft floor to gold prices.

While we are currently in a phase where good economic news is bad news for gold as well as risk assets as monetary policy tightens in response, it won’t be long before we transition to a phase where bad economic news will be good news for gold as investors rush to relative safety and still bad news for risk assets as the economic situation deteriorates. Build and maintain a 10-15% allocation to this portfolio diversifier to brace your portfolio for the impending volatility.