Why there might still be a bull case for gold in 2023 after February's plunge
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The gold price tumbled 5.2% in February amid U.S. economic data that surprised to the upside, driving yields and the dollar higher. However, looking ahead, some market watchers believe gold could hold the $1,800 an ounce level, although this could change when the next round of data comes out.
The next prints we're expecting are the nonfarm payroll report on Friday and the U.S. inflation reading on Tuesday.
U.S. dollar was the heaviest weight on gold in February
In its latest "Gold Market Commentary," the World Gold Council reported that the yellow metal ended February at $1,825 an ounce, off 5.2% since the end of January. As the gold price returned to about where it started 2023 at, its February decline marked a reversal of the four-month pricing trend it has shared with most other assets.
The World Gold Council largely blamed last month's decline on the stronger U.S. dollar, noting that the price declines were far less pronounced in other currencies. For example, the yellow metal's price was off by only 0.7% in the yen, 2.6% in the euro, 2.8% in the pound, and 2.7% in the Canadian dollar.
Other factors that weighed on the gold price in February included momentum and rallying yields. According to the council, the only cushion for gold came in the spike in U.S. breakeven inflation.
Of course, weakness in gold-backed exchange-traded fund flows matched the weakness in the gold price. European ETFs continued to shed assets while North American funds recorded only marginal outflows in February, the first ETF outflows for the region in two months.
The Commodity Futures Trading Commission resumed publishing its commitment of traders report, albeit with a significant lag. However, it did show that net longs in gold by managed money grew $850 million or 15 tons at the end of January. The World Gold Council sees this result as consistent with the metal's price performance that month.
Is there still a bull case for gold in 2023?
Even though February erased most of January's gains for gold due to the surprisingly strong economic data that drove the dollar and bond yields higher, the World Gold Council continues to argue its bull case for the precious metal.
The council maintains that its thesis for 2023 remains intact, explaining that the markets appear to be taking the recent economic data at face value. Meanwhile, fears that more aggressive monetary policy may be needed to rein in inflation continue to swirl.
Recent commentary from Federal Reserve Chair Jerome Powell was not encouraging. Earlier this week, he said the Fed would probably need to raise interest rates more than expected due to the strong economic data. Powell also said they're prepared to stake even larger steps if the "totality" of the incoming information suggests more must be done to tame inflation.
Of course, such plans revolving around the surprisingly strong data are generally not good for gold or risk assets. As a result, most assets reversed their four-month trends after the recent commentary. However, the World Gold Council argued that the January data was merely a "blip," adding that the possibility of an economic slowdown remains on the table. It admitted that a "good" case for gold is still in play for this year, although risks remain.
The council cited several factors that could drive the metal higher, including elevated geopolitical risks, an economic slowdown in developed markets, peaking interest rates, and risks to stock-market valuations. The World Gold Council has also been monitoring gold purchases by central banks and believes continued buying can't be ruled out.
A shift in consensus
According to the council, the consensus had decided in December amid the aggressive tightening and high inflation that a recession would hit in the second quarter. However, expectations have now become more optimistic. In fact, some forecasters are predicting no landing at all rather than a hard or soft one.
In other words, they're looking for the absence of a slowdown in growth. The World Gold Council cited two contributors to this shift in sentiment as the U.S. employment and ISM survey data. Both prints brought strong numbers that appear to have since been backed up by additional releases.
Treasury Secretary Janet Yellen clarified the situation by saying, "You don't have a recession with unemployment this low." At face value, it looks like the unprecedented tightening cycle hasn't even put a dent in the robust economy, which means additional tightening is needed to rein in demand.
Poking holes in the robust job market thesis
Of course, economic resilience can't be fully ruled out, but the World Gold Council made its case for January's economic surprises to the upside were only a "blip." For example, it addressed Yellen's comment by noting that cyclical unemployment lows have preceded almost every recession since 1971.
Additionally, the World Gold Council pointed out that the unexpectedly large nonfarm payroll job number was the latest in a series of economic data prints suggesting a robust labor market for over a year. However, it added that the household survey seems to disagree with those job numbers.
The payrolls report includes data from employers on the number of jobs held, while the household survey counts the number of employed people. Drawing from both data sets, the World Gold Council suggested that the number of people holding multiple jobs has been increasing, possible to deal with soaring prices.
Additionally, this trend has limits and does not reflect a strong economy. The council also noted that the payroll survey can be subject to both large seasonal and statistical adjustments.
Pushback from the bond market and other areas
The World Gold Council also pointed out that the yield curve is now at its deepest inversion since 1981. On average, an inversion has occurred nine to 18 months before a recession.
In fact, the New York Fed's own recession model displays a higher probability of a recession now than it did in six of the last eight recessions. The World Gold Council noted that the 10-year less three-month yield spread inverted in December, the last in a long line of spreads to flip into the red.
It also argued that financial conditions are in recession territory because households and businesses are "constrained, reporting recession-level tightness in lending standards and loan demand." Additionally, the World Gold Council pointed out that the only reason retail sales beat expectations in the last print was because of inflation. Rather, households are spending more but buying less.
In its 2023 outlook, the World Gold Council gave a consensus view of a mild recession but potentially biased toward the more severe end of the spectrum. It maintains that the recent data prints have not dented this view.
Recessions are usually good for gold
Historically, recessions have been good for the gold price, with the yellow metal generating strong returns in five of the last seven recessions. The World Gold Council also noted that weakness in risk assets and accommodative interest rates haven been primary drivers in the past.
Additionally, equities look particularly fragile right now, both relative to bonds and to history if a recession occurs. The council believes equities are currently unattractive and will be overvalued if a recession hits.
Of course, if China's growth resurges, it might not only boost growth in other parts of the world but also export even more inflation to the rest of the world. Meanwhile, the Fed has already made it plain that it won't be pivoting anytime soon. This is a Fed driven by the economic data releases, so a pivot can't be expected until multiple weak data points are released.
The World Gold Council noted that if a pivot occurs as inflation falls, real returns on bonds could become far more attractive than where they stand at current levels. Real rates now sit between 150 and 180 basis points, a level that hasn't been a headwind for gold in the past. However, if they rise much higher, they could become a headwind for the yellow metal.
Ultimately, the council expects that if the data becomes recessionary again, gold should benefit. With real bond yields still relatively low, equities showing signs of weakness, and gold 30% off its September rally, the World Gold Council feels the case for gold "is good and reward to risk is rising."
