In 2021, gold was buffeted by opposing forces that threatened to push its price in either direction, but the result was a stagnated gold price as those forces essentially canceled each other out. In 2022, we expect more of the same forces to keep pressing against each other, although this year, the Federal Reserve will probably do more than talk like it did last year.
As a result, investors should keep an eye on what the Fed actually does, which could significantly impact the gold price in 2022. Analysts are weighing in with their expectations for the price in the next 12 months.
Gold price action in 2021
The World Gold Council pointed out that gold ended 2021 about 4% lower at $1,806 an ounce after rallying into the end of the year. However, the year-end rally wasn't enough to offset the weakness in the first half of the year. The council explained that in early 2021, the first COVID vaccines were rolled out, and optimism among investors likely drove a reduction in portfolio hedges, weighing on gold's performance and driving outflows in gold ETFs.
The rest of the year brought the pressure of opposing forces battering the gold price. Uncertainty around new COVID variants, growing risks of persistently high inflation, and rebounding demand for the metal among consumers drove the price higher. Meanwhile, rising interest rates and a strengthening U.S. dollar pushed back. The dollar strength resulted in positive gold returns in other currencies, including the euro and yen.
The World Gold Council said in its 2022 outlook that rising opportunity costs were one of the most significant negative contributors to gold's first-quarter performance last year. They also worked against the metal intermittently in the second half. Meanwhile, growing risks, especially pertaining to inflation, drove the gold price higher as the year's end approached.
In the end, interest rates and inflation were two of the strongest forces impacting the gold price in 2021.
A more hawkish Fed
The Fed's recent commentary has pointed to a more hawkish stance this year. It expects to hike interest rates about three times this year more quickly than expected while also reducing the size of its balance sheet. However, the World Gold Council analyzed previous tightening cycles and found that the Fed typically doesn't tighten policy as aggressively as committee members initially expected.
The organization also noted that market expectations of future policy actions by the Fed as expressed through bond yields have historically driven the performance of gold prices. As a result, gold has usually underperformed in the months leading up to a Fed tightening cycle but then dramatically outperformed in the months following the first rate hike.
The World Gold Council believes the dollar may have partly aided the gold price as it followed the opposite pattern. Further, it said U.S. equities have historically delivered their strongest performances before a tightening cycle and weaker returns after.
In his gold outlook for 2022, Saxo Markets' Ole Hansen advised investors to watch what the Federal Open Market Committee does rather than what it says. He believes investors who get the Fed's actions and the direction of the Chinese economy right this year will probably be the ones with the largest profits on their investments.
Hansen also doesn't think U.S. real yields can rise to the extent that others are forecasting and believes U.S. stocks will have a challenging year. He expects gold to produce positive returns this year, again "showing its credentials as an investment that over time improve [sic] returns while reducing risk and overall volatility in a portfolio."
The World Gold Council also noted inflation's role in gold's price action. Many central banks, including the Fed, initially played down concerns about inflation. However, the Fed and some others have acknowledged the possibility of rising inflation.
The World Gold Council believes the widespread view among central banks is that inflation will dissipate, but investors appear to be less sure. It cited a poll it conducted in December, which found that the vast majority of investors expected inflation to remain high, but over 25% of respondents expected it to cool.
The council sees multiple reasons for inflation to remain high, partially due to the unprecedented monetary and fiscal policies rolled out to deal with the effects of the pandemic. Some of these reasons include lingering supply chain disruptions, tight labor markets, higher average savings, and high commodity prices.
The World Gold Council reminded readers that gold tends to perform well during periods of ultra-high inflation. During years when inflation ran higher than 3%, the gold price rose an average of 14%. Additionally, it pointed out that gold has outpaced U.S. inflation in the long run, moving closer in pace to the money supply, which has significantly increased in recent years.
Real rates expected to remain low
Although some central banks will likely raise interest rates this year, the World Gold Council expects nominal rates to remain low versus history. It also predicts that elevated inflation will restrain real rates. That's an important point for gold because its short- and medium-term performances tend to hinge on real rates, which combine two key drivers for the gold price: opportunity cost and risk and uncertainty.
The World Gold Council also pointed out that low nominal and real interest rates are moving investment portfolios toward risk-on assets, increasing the need for gold and other high-quality liquid assets. It's been about two years since the pandemic began, and global stocks have soared since their 2020 lows, although the council notes that tail events have also increased.
The council expects pullbacks to continue in stocks amid the continuing stream of new COVID variants, ongoing geopolitical tensions, and sky-high stock valuations driven by a long-lasting, ultra-low-rate environment.
The World Gold Council believes all these factors combine to make gold a valuable tool for risk management. The yellow metal has historically been shown to mitigate the negative impact of pullbacks in the stock market during times of systemic risk.
Other drivers of the gold price
The World Gold Council also pointed out that investment demand isn't the only driver of the gold price. Gold exchange-traded funds, over-the-counter contracts and derivatives drive part of the price, especially over the shorter term and with sizable price movements. Variables like interest rates, inflation, exchange rates, and flight-to-quality flows all impact investment demand for gold.
However, the World Gold Council has found that other demand components like jewelry, technology and central banks also impact the gold price. These elements of gold demand do not drive significant price movements like those driving investment demand, but they do provide support or create headwinds for the gold price.
The council believes gold can receive positive support from major jewelry markets like India this year. However, it admits that there's a chance that additional slowdowns in the Chinese economy could limit jewelry's contribution to gold demand.
On the other hand, demand from central banks could be a key source of demand this year after rebounding in 2021. The World Gold Council sees good reasons for central banks to increase their gold holdings as part of their foreign reserves.
It argues that combining central bank demand with the low interest rate environment makes gold look attractive. The council also reported that two developed market central banks joined the list of buyers in 2021, although emerging market banks have dominated it since 2010.
Which factors will win out in the battle for the gold price in 2022?
The World Gold Council pointed to two primary headwinds for the gold price this year: higher nominal interest rates and the potential for a stronger dollar. On the other hand, supporting factors could include persistently high inflation, market volatility caused by COVID, geopolitics, and other factors, and robust demand from central banks and the jewelry market.
The council noted that the gold price would be driven by the factors that end up tipping the scale. However, it believes the metal's value as a risk hedge will be particularly important for investors this year.
It's anyone's guess what will happen to the gold price this year, but the fact that it continues to hang on to the psychological $1,800 an ounce level is critical. It will all depend on which force is strong enough to offset the others.