2021 was a great year for risk assets with equities and crypto markets touching all-time highs. The outlook for 2022 is more uncertain as central banks turn hawkish to fight inflation pressures. In this environment, gold is showing relative strength early in the new trading year.
Gold versus real yields
The relationship between gold prices and interest rates is key to understand movements in the precious metal. Real rates capture the inflation-adjusted opportunity cost of holding gold in a portfolio. Gold does not yield any cash flows, and low rates mean that a gold holder does not lose out on much interest income. The theory goes that when rates are high, an investor will reduce gold holdings and reallocate funds to higher yielding assets, leading to lower prices for the precious metal.
The run-up in gold prices in the second half of 2020 to above $2,000/troy ounce coincided with a decrease in rates as central banks extended support to COVID-struck economies. Real rates – as measured by the Federal Reserve’s inflation indexed 5-year yields1 - bottomed out at around -2% in early 2021, where they stayed for the rest of the year. Starting in November 2021, however, real rates have been on the ascendency. In light of persistent high inflation (the U.S. recorded 7% annual inflation in 2021, the highest since 1982), some market watchers expect the Federal Reserve to raise rates aggressively starting in early 2022. This is pushing up the rates complex and dragging real yields higher. And yet, the gold price has not reacted negatively to this potential headwind. It is possible that gold bulls price in higher inflation than what the market expects (meaning lower real rates), or that the market overestimates to what extent the Fed may raise rates - again, meaning lower rates and more support for gold.
Meanwhile, geopolitical risks have certainly increased with a crisis unfolding between Russia and the Ukraine that could yet result in armed conflict in Europe. This comes on top of ongoing tensions between the U.S. and China over Taiwan as well as the threat of conflict in Korea. For many investors, the precious metal could appeal as a safe haven asset.
When markets are stressed … gold can outperform
Equities markets got off to a rocky start in 2022. Investor sentiment has turned against some of the stocks that had driven equities to record highs. The tech-heavy Nasdaq-100 index is underperforming the broader S&P 500 Index as investors reassess valuation in light of possible rate hikes and the effects of the latest COVID variant. In bearish environments, gold is showing its strength. It can serve as a portfolio stabilizer when markets are stressed. While the metal is not always immune to selling pressure (it also sold off when the world went into “lockdown mode” in March 2020), it can outperform typical risk assets in these market environments.
Crypto and gold
If equities got off to a rocky start in 2022, what can be said of crypto assets? Since hitting an all-time high on November 9, 2021, bitcoin has shed near half of its value. The ratio of bitcoin to gold shows how many troy ounces of gold you could buy with one bitcoin – the higher the number, the more valuable bitcoin against gold. Looking back over the past five years, the ratio has tended to trade around 5x – 10x before breaking significantly higher in early 2021 as the price of bitcoin rose above $60,000. At peak bitcoin prices, the ratio stood at more than 35x. It has now dropped to around 20x – a high number looking back historically but a long way off the record.
Trading activity in 2022 to date can be summarized by high volatility and selling pressure on some of the popular asset classes of the past few years. The macro outlook is uncertain with room for policy mistakes from central banks, inflation worries across many sectors of the economy and geopolitical hotspots. In this environment, gold has attracted solid interest from investors. Year to date, the precious metal is outperforming risk assets and proving a store of value in turbulent times.
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.