In our inaugural monthly exploration of the gold and silver markets, we review February, then examine the macroeconomic trends with a focus on the month ahead.
We then discuss the gold & silver markets starting with a brief review of price action and highlights during the month. Upside and downside risks are then highlighted before finishing by providing an outlook for the month ahead.
Macroeconomic Update
Worries are mounting that higher interest rates in the United States could hinder economic growth (recession/stagflation fears) and the potential for an inflation-induced monetary policy error, is increasing.
Additionally, a prolonged Russia-Ukraine crisis dragging in the West and intensifying geopolitical tensions is a notable black swan event that could further undermine global economic growth, embellishing the role of gold as a safe haven.
The minutes of January’s FOMC meeting gave a clear indicator of the Federal Reserve’s likely trajectory for increasing interest rates this year. While the committee decided to keep the interest rate unchanged for now, “with inflation well above 2 per cent and a strong labour market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.” The central bank will also be ending its net asset purchases, further underlining its hawkish pivot.
While central banks are primed to increase rates to tackle rising prices, January’s JP Morgan Global Manufacturing PMI was a reminder that the global recovery from the pandemic remains fragile. While the PMI continued the run of growth to a 19th successive month, the figure of 53.2 in January was the lowest for 15 months with JP Morgan calling it a “disappointment” that suggests the manufacturing sector is “seeing a drag”.
However, a more positive strand was that future output PMI increased, suggesting the disappointment may be temporary.
Gold
Gold was firmer in February with the price bouncing back above $1,860 and towards the $1,900 level as appetite for safe-haven assets returned after NATO warned that Russia was continuing to build up its military presence near the border with Ukraine. When Russia did then invade Ukraine towards the end of the month, the gold price jumped above $1,970.
Geopolitical rallies tend not to last unless they manage to push prices to levels where momentum and technical buying kicks in (see chart). Consequently, gold gave back its momentum-based gains but has broken out from within the large symmetrical triangle that has dominated for 11-months.
Looking further ahead, the London Bullion Market Association’s forecast survey, which was carried out before Russia’s invasion of Ukraine, predicted prices to be mostly unchanged this year compared to 2021’s average price.
The main drivers, according to the 34 analysts surveyed, will be the Fed’s monetary policy, inflation and the performance of equity markets. The LBMA survey did not consider geopolitical tension as a major driver, illustrating how a week can be a long time in markets!
Geopolitical tension is certainly gold’s key driver right now and this is supported by healthy fundamentals for the metal with strong jewellery demand from China during Chinese New Year, which was 12% higher than the previous year, according to Heraeus Precious Metals. 2022 is the Year of the Tiger with the World Gold Council suggesting that gold will be a vital asset to protect Chinese investors this year with the nation’s economy facing the dual threat of a slowdown in growth and rising inflation.
Upside risks
- Geopolitics
- Slower than expected US interest rate hikes
- Stronger inflation
- Slower economic growth (higher probability of recession or stagflation)
- Stock market downturn
Downside risks
- Aggressive US interest rate hikes
- Faster economic growth (lower probability of recession)
- Riskier assets perform stronger – stock markets and Bitcoin
- Investor demand weaker
- US dollar strength
The month ahead for gold
Gold has made a strong start to the year and is outperforming traditional assets such as bonds and equities, as worried investors seek safe havens to store their cash. Gold has regained its lustre on the back of spiralling worries over Russia’s invasion of Ukraine, concern that higher US rates could pull the break on the post-Covid economic bounce back, and the potential for an inflation-induced monetary policy error.
The correlation relationship between real interest rates and precious metals has started to weaken amid concerns about the economic outlook and rising prices. Typically, inflation-adjusted rates are inversely correlated with gold. This is because higher interest rates make non-interest-bearing assets such as gold less attractive as the opportunity cost of holding gold increases. The gold price has remained resilient even though real rates are higher.
Also, there is a realization that gold has rallied during recent tightening cycles. In a cycle of low and negative real interest rates and a hedge against economic, macro, and geopolitical uncertainty, gold is likely to remain solidly underpinned.
Silver
The past month: Having held short-term support at $21.94 silver prices rallied steadily on rising geopolitical tensions and expectations of stronger physical and investment demand. The silver price almost completely followed the fluctuations of the gold market and surged above the important $25 level in late February as Russia launched an invasion of Ukraine.
History points out that a price surge prompted by geopolitical tensions is rarely sustained and, as a result, silver retrenched towards $23 on profit-taking as gold relinquished much of its risk premium.
In the LBMA’s forecast survey, analysts are expecting silver to average $23.54 an ounce this year, a 6.4% drop from last year’s average price.
While the analysts may be bearish on silver’s outlook, the physical market is looking more buoyant with the Silver Institute forecasting demand for the metal to exceed 1.1 billion ounces on rising demand from the industrial, jewellery and investment sectors. Heraeus was similarly positive with both institutions citing the growth in the installation of photovoltaic systems and the continued rollout of the 5G network as supportive for silver.
Couple that the increased demand with dwindling supply with Fresnillo – the world’s largest primary silver producer, reducing its production guidance for 2022 – and silver looks fundamentally supported.
Upside risks
- Investor demand
- Stronger physical demand
- Green energy applications
- Stronger economic activity
- Rising gold prices
Downside risks
- Increase in mine supply
- Increase in recycling
- US dollar strength
- Downturn in global commodity and equity markets
- Falling gold prices
The month ahead for silver
Rebounding industrial activity and economic growth is likely to bolster the demand for silver from the jewellery sector.
The grey metal also has more industrial applications than gold and is a fundamental raw material for green technologies such as electric vehicles, renewable energy, and others.
Solid demand from the industrial sector is likely to maintain the silver market is a small deficit for the time being. But inventories of the metal are not lacking, hence the undersupply is unlikely to widen just yet. An eventual move to new highs for the year would clear the way for a push to the November high at $25.40, which is the confirmation point of the double bottom.
Given the bullish outlook for gold, it seems that silver’s downside is probably limited. Dips back to the $23 are likely to be viewed as buying opportunities.
Find out more about what Kinesis has to offer
Rupert is a Market Analyst for Kinesis Money, responsible for updating the community with insights and analysis on the gold and silver markets. He brings with him a breadth of experience in writing about energy and commodities having worked as an oil markets reporter and then precious metals reporter during the seven years he worked at Bloomberg News.
As well as market analysis, Rupert writes longer-form thought leadership pieces on topics ranging from carbon markets, the growth of renewable energy and the challenges of avoiding greenwash while investing sustainably.
