Gold Market Commentary: Select elections and Fed on a dime

February review

Gold fell by 0.3% in February on a rise in risk appetite and higher Treasury yields. But a bounce in early March has seen gold hit new all-time-highs.

Looking forward

A Fed meeting with new dot plots and Iranian parliamentary elections are events to watch in March, with monetary and geopolitical uncertainty high.
 

Gold pares back on rates and Mag7

Gold prices retreated to US$2,048/oz by the end of February, a 0.3% m/m fall.¹  Nonetheless FX volatility has ensured that y-t-d returns remain positive in four of the major currencies (Table 1). 

As per our Gold Return Attribution Model (GRAM), a sharp move higher in the US 10-year Treasury yield (+34bps) appeared to be the major culprit in driving gold lower (Chart 1) – understandable given the barrage of positive inflation and economic surprises over the past two months. Aggressive risk-on positioning driven by continued outperformance from the Magnificent Seven (Mag7)², amid the AI frenzy, also likely contributed to gold’s lacklustre performance this month. Although prices staged a comeback on the last day of the month. But the gold price staged a comeback on the last day of February, since when it 
has moved above US$2,100/oz.

Looking forward

• Iran’s parliamentary elections shouldn’t in themselves create waves, but the country’s consumers are major gold buyers and their elections could pave the way for an important political secession
• The March Fed meeting is important: it will provide investors, following a slew of strong data, with the first set of dot plots since December’s dovish tilt. Even though markets have priced out a cut, the argument for is as vehement as the argument against. Uncertainty reigns in monetary policy.

Election fever

2024 is peppered with political event risk as important elections line up in a more divisive world. Some of these elections have cross-border implications, increasing the overlap between politics and geopolitics, and that matters to investors (Chart 2).

As we have noted previously, geopolitical risk seems to have a significant impact on gold prices. But this is not just via the investment channel. Anecdotally in 2023, gold holders - in the Middle East and Europe in particular - were less willing to give up their gold in the face of high prices and economic distress. Adding the geopolitical risk index (GPR) to an equation for global recycling suggests it adds a significant restraint to supply from this sector (Table 2).³  We estimate the reduction in recycling to have been between 30 and 70 tonnes in 2023.⁴ It seems therefore that geopolitical risk matters – broadly – and prompts us to keep a keen eye on elections over the next few months as we gauge what they could mean for gold.

March should have seen two notable elections in Ukraine and Iran. But Ukraine, still under martial law, cancelled theirs. 

Iran’s parliamentary vote – for two legislative bodies – is likely to usher in little change in a country where voter antipathy is high.⁵ But one of these bodies might prove pivotal, both inside and outside Iran. The Assembly of Experts has one important job – to choose a new Supreme Leader. At a ripe 84, Khamenei’s secession is probably nigh. The elections on 1 March may not reveal much on the day but they could carry consequences later, because:

• Iran is the sixth largest buyer of jewellery, bar and coin⁶
• Khamenei is a known quantity and a successor may bring further uncertainty to a region already mired in it
• Iran is reportedly reluctant to directly involve itself in the issues currently taking place in the Middle East, but actions of proxy militias raise the risk that it will be drawn in.⁷ As the third largest producer of oil in OPEC+ it carries a latent marginal risk to the global price of oil and consequent inflationary and geopolitical repercussions.

Fed cuts: Will they…won’t they?

On Tuesday 20 February the Bank of England (BoE) governor, Andrew Bailey, stated that for the BoE rate cuts don’t require inflation at target. A bold statement from one of the major central banks and fodder for doves. Yes, the UK just experienced a statistical recession and pain is being more viscerally felt in the household sector here than in the US, but it could embolden rate doves, with investors having unwound almost all of their rate-cut bets since January (Chart 3).

Whether the Fed heeds the wishes of other central banks or the market - both unlikely - is another thing. As we stand on the decision precipice, the market appears to have thrown in the towel for cuts in March, and possibly, May. This is despite equally vehement arguments for and against, which broadly go along these lines:

Hold: The Fed has achieved stable at-target inflation and full employment, and financial conditions are no longer constrictive.⁸ The economy can handle rates at these levels and they provide a policy buffer in the event of a recession.

Cut now: The Fed doesn’t need to risk a recession now that inflation is back at target. Leading indicators and delinquency rates are pointing to a slowdown. The central bank doesn’t want to be late again, and the US is running the biggest non-crisis deficit in modern history. It’s holding up the economy.

But to add to the confusion, the Fed can be unpredictable. The dovish pivot in December, even as strong inflation and economic data tumbled in, proved that second guessing the Fed can be a gamble.

Of additional interest of course will be the dot plots. Does the Fed backtrack on its dovish turn in December? Will the wide dispersion in the dots narrow? Will the market show more restraint than it did following the December meeting?

We remain of the mind that cuts will eventually come this year and recession risk remains tabled. But even if policy rates come down, long maturity yields are not destined to follow. Does that bode ill for gold? Not necessarily. The two key buyers in 2023: central banks and emerging market retail investors, are not particularly wedded to long maturity US yields. Furthermore, a failure of yield drop, aided by a run-down in the Fed’s Repo facility (RRP), could be a continued symptom of higher-term premia, not rosy growth expectations. This was reflected at times during 2023 as a reluctance by investors to absorb Treasuries given worrying underlying fiscal and debt dynamics.

To conclude

Elections will come thick and fast this year. Some outcomes will be domestically contained but others may spill over into the current tense geopolitical climate. The Iranian parliamentary election in March promises little directly, but could pave the way for an important secession. Iran is a major buyer of gold and an OPEC+ member, so the potential for a conflagration exists. Although we have no record of local gold market activity during the previous Supreme Leader secession (in 1989), the geopolitical ramifications of a change could range from damp squib to material.

The Fed meets in March and will produce its first set of dot plots for the year. The market has all but unwound its expectations for a cut in March (as well as May). But the Fed has surprised before and a pre-emptive cut should not be ruled out entirely. Relative calm in volatility measures (MOVE for bonds and VIX for equities) suggests surprises could elicit strong market moves.

Gold’s strong bounce at the start of March has taken gold to new consecutive all-time highs.⁹ This suggests a market itching for a trigger, aided by recent strong reported Chinese demand, a quietly bullish sell-side gold forecasts and weaker US ISM numbers on 1 March.^{10, 11}

Footnotes

¹Based on the LBMA Gold Price PM as of 29 February 2024

²Magnificent 7 Stocks: What You Need to Know (investopedia.com)

³We get a similar but less significant finding for jewellery and bar and coin demand.

⁴We estimate the impact of GPR using two methods: 1) we estimate our regression to Q4 2022 with and without GPR and compare the estimated tonnage difference in 2023 between the two; 2) we estimate the tonnage impact, setting GPR to zero for 2023 in our ‘with GPR’ regression in 1.

⁵The 2024 Election Cycle Starts in Iran | The Washington Institute.

⁶Calculated as the five-year annual average between 2019-2023.

⁷Analysis: Iran doesn’t want war with the US despite chest-beating rhetoric (alarabiya.net); Opinion | Why Iran Doesn’t Want a War - The New York Times (nytimes.com).

⁸Chicago Fed Financial conditions index. BoFA Financial conditions index.

⁹At the time of writing, the LBMA Gold Price PM reached a record high of US$2,142.85/oz on 6th March, after breaking previous records on the 4th and 5th of March

¹⁰Analysts forecasts | LBMA.

¹¹US manufacturing contracts further, rays of light on the horizon | Reuters.