Familiar Catalysts Could Boost Gold Prices

Using the SPDR Gold Shares (NYSEARCA: GLD) as the measuring stick, gold is having a decent year. The world’s largest gold-backed exchange traded fund is higher by nearly 5% as of July 5.

That’s a welcome sign that bullion is finally proving responsive to stubbornly high inflation, fulfilling its obligations as a favorable hedge against rising consumer and prices. GLD and its counterparts aren’t beating stocks – that’s a good thing – but the gold ETFs are pacing well ahead of the Bloomberg Aggregate US Bond Index.

Advisors know this, but many clients do not: There are four factors that primarily determine gold’s price action -- jewelry, investment, technology and central bank net purchases. Fortunately for clients craving the portfolio diversification offered by commodities, including gold, some of those tailwinds and others are in place today for more upside for the yellow metal.

Dollar, Interest Rates Could Portend Bullion Upside

The U.S. dollar and interest rates are often intertwined, meaning that when the former rise, so does the dollar. A strong dollar, as was witnessed last year, is negative for commodities, including gold, because the asset class is priced in greenbacks. Fortunately, some experts believe the dollar could be poised for a second half slide and that could be a boon for bullion.

“Historically, gold and the U.S. dollar have shown an inverse relationship to one another: When the dollar’s value declines relative to other currencies, the price of gold tends to increase, and vice versa,” notes Morgan Stanley’s Christopher Baxter. “There is strong potential for a weaker dollar in the second half of 2023, which could drive demand and higher prices for gold. In fact, in the last 40 years, gold has delivered the best six-month returns when the dollar has fallen from elevated levels.”

Of course, the dollar’s decline and thus gold’s rise would likely be hastened if interest rates decline. That possibility is in play, particularly if inflation trends lower, providing the Federal Reserve with the latitude to not hike borrowing costs now through the year-end.

“Gold is considered a ‘long-duration’ asset, meaning it may be especially sensitive to changes in interest rates,” adds Baxter. “For example, over the past 25 years, the price of gold has risen about 10% for every percentage point of decline in the inflation-adjusted, or ‘real,’ interest rate of the benchmark 10-year U.S. Treasury bond. That’s noteworthy for investors today because the Federal Reserve, after rapidly increasing rates to tame decades-high inflation, may eventually start cutting them, potentially sending the price of gold higher.”

Other Important Catalysts for Gold

It should be noted to clients that jewelry is prominent in the gold price equation. Of course, consumers are fickle, meaning it’s positive when other demand drivers emerge.

That’s happening due in large part to global central banks, which are on bullion buying binges. Indeed, those market participants qualify as “smart money.”

“In 2022, central banks bought gold at the fastest pace since 1967, at about 1,136 tonnes,” concludes Baxter. “This year, central bank purchases hit 228 tons in the first quarter, breaking the first-quarter record previously set in 2013—and there is little indication that the pace will slow.”

That trend is expected to continue as more central banks look to guard against inflation and diversify portfolios away from holdings in major currencies, such as the dollar and euro.

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