The failure of Silicon Valley Bank and Signature Bank this past weekend sparked concerns over banking stress contagion. The jury is still out on whether it’s a few bad apples or the whole cart but taking no risks, governments were quick to emerge with monetary disinfectant on Monday. An article in the FT summed up the probable outcomes of the bank failure and its subsequent policymaker remedies.1 Here’s what they might lead to and what it might mean for gold.
The SVB episode is likely to increase funding costs for banks, especially smaller regional banks. It highlighted the issue of Held-to-Maturity2 assets and in addition, the recent aggressive run up in interest rates has not been accompanied by a similar rise in deposit rates. The sensitivity of the latter to the former is known as the deposit beta. It has been low for a while.3 A drive by banks to retain deposits could materially drive up the rates paid on them. With funding costs higher, and reports of deposits moving from smaller, regional bank to large too-big-to-fail institutions, banks are likely to curtail some lending too. This would lead to a further tightening of financial conditions. VC and tech companies and their founders and executives may find less understanding institutions than SVB reputedly was.
The second scenario could be a reticence by the Fed (and potentially other central banks) to continue on their aggressive policy path, particularly as impact of policy tends to arrive with a lag as we have seen. The sizeable collapse in the 2-year Treasury yield (-61bps, largest drop since Oct 1982) and the implied fed funds terminal rate (-80bps) suggests as much (Chart 1).
Chart 1: The Fed funds rate is now expected to peak in May, 80bps lower and four months earlier than last week
Source: Bloomberg, World Gold Council
*Based on implied Fed rate changes from the Fed fund rate futures’ market.
Third, digital currencies pegged to the US dollar are facing stronger regulatory scrutiny and cryptofirms may also struggle to access the US banking system as easily as in previous years following the failure of Signature over the weekend and Silvergate Bank a few days before.4
These three scenarios all look gold friendly. Tightening standards weakens the corporate and consumer sector and by extension the economy, inching the US closer to an official recession. Recessions have historically been good for gold. A lower ceiling for interest rates is gold friendly too, limiting the opportunity cost of holding gold. But a stalwart Fed possibly risks creating bigger problems down the line. Finally, concerns about systemic risks to bank deposits – whether warranted or not – may lead to investors moving some of their currency holdings into gold. A sign of this were the 16t (US$1bn) of inflows into global gold ETFs this week so far, reversing ten consecutive weeks of outflows.
Faced with banking troubles on both sides of the Atlantic as well as uncertainty surrounding inflation and central banks, markets have gone through a brutal few weeks in terms of interest rate volatility (Chart 1).
Chart 1: Interest rate volatility is on the rise again after breaking below the symbolic 100 level in the MOVE index in early February*
*As of 15 March 2023. Source: Bloomberg, ICE BofA Move index, World Gold Council
Gold has been directly impacted by these recent moves in interest rates (Chart 2). First, a sequence of stronger-than-expected US economic data prints (payrolls and retail sales in particular) and a barrage of hawkish comments from US Federal Reserve speakers generated a meaningful repricing up of the Fed Funds rate trajectory, negatively impacting gold. Next, a sharp risk-off move – triggered by mounting financial stability fears after the collapse of Silicon Valley Bank, Signature Bank and Credit Suisse – sent peak Fed rates down again, propelling gold higher. In this process, the implicit peak of the rate cycle has shifted from October back to May 2023, which means that the market is now expecting the tightening cycle to end much sooner.
Chart 2: Gold price reacting to recent fluctuations in interest rates*
*As of 23 March 2023. Source: Bloomberg, World Gold Council
What next for monetary policy and gold?
As it currently stands, how long the Fed will hold rates at elevated levels remains unknown. What is clear is that the Federal Open Market Committee is determined to avoid a replay of the 1970s and is under a lot of pressure to display an unwavering commitment to fighting inflation, even if, as some investors have suggested, its actions push the US economy into recession.
What is also clear is that getting inflation down to central banks’ 2% target is causing both economic and financial damage. The failure of two US regional banks and a major Swiss bank and the surge in UK government borrowing costs last year show that the effects of monetary tightening take time to filter through the economy and that the vulnerabilities associated with an aggressive tightening phase often show up in unexpected places. This will probably warrant caution on the part of the Fed, reinforcing our view that we may be closer to the peak of central bank hawkishness. This scenario would support gold particularly if accompanied by a mild recession – after all, a key issue over the coming months will be the extent to which the crisis of the past week causes banks to tighten credit (Chart 3). This in turn would weigh on consumer demand and business investment and therefore hurt growth.
Chart 3: US financial conditions have deteriorated suggesting availability and cost of credit have worsened*
*As of 20 March 2023. Source: Bloomberg, Bloomberg United States Financial Conditions Index, World Gold Council
Long-term trends should continue to support gold
Looking along the investment horizon, it is also unlikely that gold will be met by headwinds from higher interest rates. There are risks to this outlook, of course, notably sticky inflation or bouts of inflation – due to long-term shifts in dynamics such as the clean energy transition or potential deglobalisation – which would keep Fed policy tight. That said, long-term structural indicators do continue to point to a low-growth, low-yield environment anchored by slow labour force growth and weak productivity growth (Chart 4).
Chart 4: Headwinds for trend growth continue to anchor real interest rates*
*Data from March 1957 to December 2022. Trend growth is the sum of long-term labour force growth and productivity growth. Labour force and productivity growth rates are 10-year annualised numbers. Source: Bloomberg, Bureau of Labor Statistics, World Gold Council.
Moreover, debt levels also continue to be high, further constraining a strong growth environment. In fact, businesses, consumers and governments face increasing interest costs as a percentage of income, reducing expenditure and growth potential in the economy.
Demographics have also been trending downward for several decades and are expected to continue to do so in high-income countries (Chart 5). This is important as it determines the relative number of (net) savers and borrowers in the population of a country. Young people are generally borrowers. Middle-aged and elderly people are generally savers. An ageing population means that there are fewer opportunities for savers to deploy their savings. This creates a borrower’s market in which interest rates are pushed lower to encourage more borrowing.
Chart 5: People are living longer and having fewer children, leading to a greater proportion of elderly in the population*
* Data from 1960 to 2020. 2021 to 2050 are forecasts. Source: The World Bank, World Gold Council.
In summary
Cyclical developments in growth and inflation will dominate the short-term outlook. And while it is likely that the Fed pricing moves back up again, especially if recent financial sector fears can be put in the rear-view mirror, investors should keep an eye out for a hint from the Fed that it is close to done. This could provide more support for gold.
Longer term, gold has a key role as a strategic long term investment and as a mainstay allocation in a well-diversified portfolio. While investors have been able to recognise much of gold’s value during times of market stress, the structural dynamics pointing towards a low-growth, low-yield environment should also be supportive for the precious metal.
Japan’s 2023 spring wage negotiation sees the largest pay increase in 30 years
While this helps ease the pain of rising living costs, it may contribute to inflationary pressure
Coupled with the possibility of slower growth, the risk of stagflation could hit Japanese investors
Historical data shows that gold outperforms all other major assets during stagflationary periods
Japanese employees could see the biggest overall pay rise for 30 years
The 2023 “Shunto” sent positive signals to Japanese employees regarding possible pay increases amid a backdrop of elevated inflation in the region. Shunto – the wage negotiations between major corporations and unions that take place every March – provides pay level guidance for all Japanese employers, large and small. This year, the main labour unions and employers agreed on a 3.8% pay rise, the highest since 1993 (Chart 1). In addition, the basic wage will increase 2.3% this year, the highest increase since 2015, when Rengo, or the Japanese Trade Union Confederation, began to publish such data.
And while final Shunto results and actual pay rises across Japan may differ from the initial negotiations, the trend is clear: Japanese employees’ earnings are rising. The Fast Retailing Co. announced pay rises of up to 40% in January, and other enterprises including Nintendo, Toyota and Panasonic are giving their employees wage bumps not seen for years. 1
Chart 1: 2023 Shunto result sees the highest overall pay rise for 30 years
Source: Rengo, World Gold Council
Pay increases may alleviate some cost of living pain but they may contribute to sustained inflationary pressure
There is no doubt that these pay increases will help relieve pressure on local households from rapidly rising living costs. Japan’s core inflation grew at 3.5% y-o-y in February, the fastest since January 1982 (Chart 2). According to the Bank of Japan’s (BoJ) opinion survey, more and more households are feeling the current economic pressure and nearly 90% blamed high inflation; more than 50% felt that price levels have gone up significantly.
Chart 2: Japan’s inflation pressure remains elevated – local households feel the pain
Source: Bloomberg, World Gold Council
But higher wages could contribute to inflationary pressures in Japan. Our analysis finds that every 1% y-o-y increase in wages leads to a 0.1% rise in y-o-y CPI (Chart 3). And the former BoJ governor Kuroda also noted that a 3% wage increase would be needed for local inflation to sustainably rise above the target - although he didn’t clarify which type of wages. 2
Furthermore, supply-side inflationary pressures remain a concern, particularly as crude oil prices have rallied in the recent OPEC+ output cut 3 and over 90% of Japan’s energy resources rely on imports. 4
Chart 3: Wages positively impact inflation growth in Japan
Source: Bank of Japan, Bloomberg, World Gold Council
Stagflation risk is rising
Meanwhile, Japan’s economic recovery is facing challenges. For instance, the increasing risk of a global recession and systemic turmoil in the global financial sector, fuelled by the recent banking industry crisis, could weigh on Japan’s recovery as it is highly dependent on external demand. And the aforementioned wage rises, if not transmitted into sustainable economic growth, may intensify stagflationary risks.
This possibility of slower growth and rising inflation, or stagflationary pressure, is likely to make Japanese investors restless. After all, financial assets in Japan have performed poorly during past stagflationary times. But gold has outperformed all other major assets during stagflationary periods in Japan (Chart 4). These periods are typically characterised by heightened financial market volatilities, elevated inflation and sluggish growth that keeps interest rates low. All of these lay a foundation in which gold thrives.
Chart 4: Gold, in yen, thrives in various economic scenarios, one of which is stagflation*
Source: Bloomberg, World Gold Council
*Based on q-o-q changes in Japan CPI, GDP, LBMA Gold Price PM, Bloomberg Commodity Index, Bloomberg Barclay US Aggregate Index, MSCI World Index, Bloomberg Barclay Global Aggregate Index, Tokyo Stock Exchange Index and Nomura Bond Performance Index JGB between 1972 and 2022. All calculations are in yen. Goldilocks: GDP up, CPI down; Reflation: GDP up, CPI up; Stagflation: GDP down, CPI up; Deflation: GDP down, CPI down.
Gold, in yen, has already outperformed major assets in Q1 2023 in the face of heightened concern around a possible global recession (Chart 5). Looking ahead, while recession may be inevitable, the risks mentioned above add further challenges to Japanese portfolios. Gold, a safe-haven asset with low correlation to risk, often rewards investors with superior returns and portfolio protection during such periods.
Chart 5: Gold, in yen, saw a 9% return in Q1 2023, outperforming major assets
• According to the IMF, 1 reported global central bank gold reserves remained virtually unchanged in March. • Available data shows purchases almost perfectly offset sales, resulting in a net increase of 0.2 tonnes.
Central bank gold reserves virtually unchanged in March based on reported IMF data*
*Data as of 31 March 2023 where available. Source: IMF IFS, respective central banks, World Gold Council
China reported its fifth consecutive increase to its gold reserves, adding 18 tonnes in March.
Reported PBoC gold reserves have now increased for five consecutive months*
*Data as of 31 March 2023 where available. Source: IMF IFS, respective central banks, World Gold Council
Singapore followed with a reported increase of 17t, bringing its total reserves to 222t – 45% higher than at the end of 2022. In addition, India and the Czech Republic reported a more modest 4- and 2-tonne increase, respectively.
Reported sales of gold in March were driven primarily by Türkiye (15 tonnes), 2 Uzbekistan (11 tonnes) and Kazakhstan (10 tonnes). Türkiye sold the gold into the domestic market following a temporary partial ban on gold bullion imports. Further, it is not uncommon for central banks that purchase gold from domestic sources, such as Uzbekistan and Kazakhstan, to be frequent sellers of gold.
China and Singapore purchases helped offset heavy sales from Türkiye, Uzbekistan and Kazakhstan in March*
*Data as of 31 March 2023 where available. Source: IMF IFS, respective central banks, World Gold Council
Russia also showed a 3 tonne fall in official gold reserves in March after submitting previously unreported information dating back to February 2022.
Stay tuned for our Gold Demand Trends Q1 report, to be published on 5 May, which will contain more detailed information on gold demand by central banks and other official institutions.3
Monthly changes in Central Bank of Russia gold reserves*
*Data as of 31 March 2023. Source: IMF IFS, World Gold Council
Footnotes
1Based on IMF IFS data and supplemented with data from respective central banks where available and not reported through the IMF at the time of publication. IMF IFS data is reported with a two-month lag, and while most institutions report on a regular basis, some may report with a – sometimes significant – delay. Figures may be subsequently revised as more data becomes available. The data used here informs but is distinct from the central bank demand estimates we report in Gold Demand Trends. Please see footnote 3 for more information.
2Türkiye official sector gold reserves are the sum of central bank-owned gold and Treasury gold holdings. This is equivalent to gross gold reserves less all gold held at the central bank in relation to commercial sector gold policies (such as the Reserve Option Mechanism (ROM), collateral, deposits and swaps). For information on this methodology, see: Central Banks Methodology Note
3For purposes of Gold Demand Trends, central bank demand is defined as net purchases (i.e. gross purchases less gross sales) by central banks and other official sector institutions, including supra national entities such as the IMF and sovereign wealth funds where applicable. Our central bank demand data is sourced from Metals Focus, whose proprietary estimates of official sector activity incorporate various sources, including IMF IFS reports, international trade data, and others. As such, IMF IFS data is a subset of what is included in Gold Demand Trends. Both data sets are subject to revision as new information is made available and/or to accommodate late or updated data reported by official institutions.
The latest Gallup Poll Social Series monitoring public opinion on economy and finance shows that gold jumped into second place as ‘best long-term investment’ in the US this year. 1
And here’s the kicker: while higher rates seem to have dampened investors’ perception of real estate as the best long-term investment (its share of the vote plunged from 45% to 34%), they haven’t damaged perceptions of gold. On the contrary, the number of Americans naming gold as the best long-term investment almost doubled this year from last. This, despite interest rates climbing to a 16-year high in March.
Over one quarter of US adults plumped for gold as their top choice in Gallup’s April poll, the highest for 11 years. This nicely echoes our data on US bar and coin investment: in our latest issue of Gold Demand Trends we reported that US investors bought 36 tonnes of gold bars and coins in Q1 this year, up sharply on the previous quarter.
One quarter of Americans view gold as the best long-term investment*
Source: Gallup
* Q: Which of the following do you think is the best long-term investment? Base: 1,013 US adults. Survey ran April 3-25 2023.
Our own research has shown a keen recognition of gold’s long-term value proposition and safe haven attributes in the US, with around two thirds of investors agreeing that ‘gold is a good safeguard against periods of political and economic uncertainty’ and that ‘the price of gold increases over time’. 2 Unsurprisingly, this conviction increases among those who have invested in gold: 87% of gold investors in the US agree that it holds its value over the long term. 3
Gold investors are keenly aware of its wealth protection and safe-haven potential
Source: Appinio, World Gold Council
* Q: Please indicate how much you agree or disagree with the following statements for why you invest in gold. Base: 1,095 gold investors.
Gold’s recent performance may have helped to bump it up the rankings. It’s interesting to note that the respondents who already own stocks have the lowest conviction in stocks than they’ve had since 2012: only 25% of stock owners view stocks at the best long-term investment. The same number (24%) think gold is better up to the task. This could be due to the relative performance of each over the past 12-18 months, with gold outshining the gloomy performance of US stocks.
And as US consumers raise their longer-term inflation expectations, gold’s historical performance as an inflation hedge may also be at play. According to the Gallup poll, conviction in savings accounts/cash deposits as a good long-term investment increased only slightly this year, even with cash deposit rates reaching 5%. But these rates are still quite poor in real terms and anyone expecting persistent inflation may be tempted more by the long-term investment proposition of gold than that of savings accounts. Our research shows that gold’s potential to ‘protect against inflation/currency fluctuations’ is well recognised among gold investors.
All in all, the survey results point towards Americans being familiar with gold’s potential for long-term wealth protection. Which is particularly valuable at a time when there are few – if any – dependable safe-havens also offering the potential for long-term returns.
2The World Gold Council commissioned Hall & Partners to survey 10,000 retail investors across five markets US, Canada, Germany, India and China. Retail investors were defined as people who are aware of both gold and cryptocurrencies as an investment product, and who had made at least one investment (from a defined set of products) since the beginning of 2021. Online fieldwork was conducted in late October/early November 2021.
3Online survey of 2,000 US retail investors conducted via Appinio in late August/ early September 2022, targeting respondents who had invested in gold and/or cryptocurrencies in the prior 12 months. ‘Gold investors’ were defined as survey respondents who had ever invested in gold.
SMSF investors continue to face inflationary pressure not seen in decades. And it could influence investment performance if the potential effects are not considered.
It has been more than 30 years since the Consumer Price Index (CPI) reached 7%1. The effects of rising inflation and subsequent central bank interest rate decision making were plain to see by the end of 2022. Having surprised markets by another 25bp hike in June, the RBA noted in their recent statement, that while inflation in Australia has passed its peak, it is still too high at 7% and that it will be some time before it is back within their target range of approximately 2%-3%2. And the governor noted upside risks to the inflation outlook has increased and “the path to achieving a soft landing remains a narrow one”.
Additionally, the vulnerability of global capital markets from negative shocks remain. The most recent example being the collapse Silicon Valley Bank (SVB), coupled with Credit Suisse a few days later. Investors started to call into question the stability of the banking industry which helped move gold over the US$2,000 level, and coupled with a weakening FX rate, gold recorded its highest ever price in Australian Dollars in early May3.
2022 and H1 2023 returns from major assets in Australian Dollars*
Source: Bloomberg, World Gold Council
*As of 31 December 2022. 2023 Y-t-d refers to 30 June 2023. Based on LBMA Gold Price PM, AusBond Bank Bill Index, AusBond 0+ Composite Index, Bloomberg Barclay Global Agg, ASX300 Index, MSCI World Index, ASX300 A-REIT Index, FTSE EPRA/NAREIT Developed ex-Australia Index, FTSE Developed Core Infrastructure Index. All calculations are in AUD.
Where could this lead?
With the upside risk to future inflation rising and local economic outlook dimming, the traditional warning signs of stagflation exist. Stagflation is defined as an economic cycle characterized by slow growth and a high unemployment rate accompanied by high inflation. The most notable period in Australia occurred in 1975 when a recession begun after the price of oil quadrupled.4
In addition, the global geopolitical landscape is potentially hindering economic recovery efforts worldwide. The ongoing situation in Ukraine, and tensions between the US and China, might continue to impact financial markets. Over the coming 18 months elections in the US and EU are scheduled. There is additionally the prospect of the UK, Russia and Ukraine going to the polls. All of these events pose risk to the fragility of the economy with some being higher than others.
What should an SMSF investor be considering?
Does your SMSF have enough protection over stubborn high inflation and other possible market events? While property is a stable long term inflationary hedge, it has had considerable setbacks over the past 24 months. Additionally, the sustained interest rises imposed by the RBA to combat inflation, may pose challenges Property is illiquid too meaning that while the long term return on investment will still remain positive, it cannot help to hedge portfolios in the short and/or medium term.
Another inflationary hedge asset, which is often overlooked by some SMSF investors is Gold. It has long been considered the hedge against inflation and market events. It can also provide accessible liquidity if and when needed. Historical data confirms its status with an annualised return of 7.6% in AUD over the past 20 years, it has outpaced the Australian and world CPIs even in calmer economic times5.
And should stagflation arise?
During stagflation periods, financial markets have seen heightened volatility while both commodities and gold fared well.6 Historical data reveals that investment portfolios have benefited from gold’s attractive returns during such periods.
As aforementioned potential risks arise, gold may have a significant role to play over the coming years to help protect and sustain portfolio performance. Our recently published investment update concluded that a portfolio comprising of assets typically held by an SMSF would have achieved higher risk-adjusted returns and lower drawdowns with an allocation to gold over a 3, 5, 10 and 20 year period.
At the very least, SMSF investors should review their existing investment strategy and ensure that it has the right protection over high inflationary pressures, and to gain a greater understanding how it could potentially perform should stagflation hit home or in the economies of interest.
A lot has been made of the convergence of yields for cash, bonds and equities (on an earnings yield basis), with the higher yield on offer in the cash space leading many investors to reassess their portfolio exposures (Chart 1).
Chart 1: Yield comparisons
Source: Bloomberg, World Gold Council. Global equities is MSCI World Index, UK corporate is Bloomberg Sterling Aggregate Corporate Index, and cash is UK Bank of England (BoE) Official Bank rate.
*Data from 31 December 2012 to 30 June 2023.
In fact, with cash yields offering compelling reward with little risk and with the balance of economic forces still appearing to be tilted against global capital markets, investors have been rushing into cash over recent months. And after years of unattractive yields, it is of course a welcome change to get some interest on defensive positions. That, however, is different to saying that holding cash today – on a long-term basis – is a no-brainer. Why? Cash yields still aren’t positive in real terms (Chart 2). In the late ’80s, ’90s and pre-Global Financial Crisis, high cash rates were associated with growing spending power. Today it’s not the case.
Chart 2: UK’s real interest rate
Source: Bloomberg, World Gold Council
*Data from 31 December 1988 to 30 June 2023.
Considering the above, rushing back to cash today – other than for tactical reasons – is not the obviously good idea it might at first appear to be. There is no certainty its purchasing power will actually hold up. So the key question of where to make long-term investments that can deliver positive real returns remains as relevant as ever, given the inflation outlook.
From an asset allocation perspective, investors should remember the longer-term historical record of equities, bonds and gold. Moreover, looking for historical guidance on which assets to hold shows the advantages of stretching your time horizon to increase certainty of achieving real returns (Chart 3).
Chart 3: Maximum and minimum real annualised returns over various investment horizons
Best and worst performance based on annualised real returns over a rolling 1-year, 5-year, 10-year and 20-year basis*
Source: Bloomberg, World Gold Council
*Data from 1972 to 2022. Computations based on y-o-y returns for each rolling window. Cash: Bank of England official bank rate. Hypothetical balanced portfolio: 60% equities (FTSE 100 Total Return index), 40% bonds (ICE BofA UK gilts Index). Hypothetical balanced portfolio with gold: 60% equities (FTSE 100 Total Return index), 35% bonds (ICE BofA UK gilts Index), and 5% gold (LBMA gold price).
Retrospectively, as one moves up the investment horizon, the range of outcomes narrows – even for a balanced portfolio, which is traditionally categorised as riskier than cash. In fact, our analysis shows that the risk-reward profile of a balanced portfolio with gold starts to look attractive relative to cash (as well as a balanced portfolio without gold) after five years. And over any single rolling 10-year period between 1972 and 2022, the worst real return for a balanced portfolio with gold is better compared to both cash and a balanced portfolio without gold. This demonstrates the advantages of focusing on long-term investments and gold’s diversification and return attributes.
If one stretches the investment horizon further, both balanced portfolios (with and without gold) have the added benefit of always delivering positive real returns over any single 20-year period over the past five decades. By contrast, cash does not, highlighting that long-term overweight cash allocations may come with opportunity costs.
In summary, our analysis shows that good investment outcomes over a medium- to long-term horizon come from good strategic decisions. Chart 3 underscores why we believe gold has a key role as a strategic long-term investment and as a mainstay allocation in a well-diversified portfolio, alongside equities and bonds.
Gold bid on banking woes
John Reade
Senior Market Strategist World Gold CouncilThe failure of Silicon Valley Bank and Signature Bank this past weekend sparked concerns over banking stress contagion. The jury is still out on whether it’s a few bad apples or the whole cart but taking no risks, governments were quick to emerge with monetary disinfectant on Monday. An article in the FT summed up the probable outcomes of the bank failure and its subsequent policymaker remedies.1 Here’s what they might lead to and what it might mean for gold.
The SVB episode is likely to increase funding costs for banks, especially smaller regional banks. It highlighted the issue of Held-to-Maturity2 assets and in addition, the recent aggressive run up in interest rates has not been accompanied by a similar rise in deposit rates. The sensitivity of the latter to the former is known as the deposit beta. It has been low for a while.3 A drive by banks to retain deposits could materially drive up the rates paid on them. With funding costs higher, and reports of deposits moving from smaller, regional bank to large too-big-to-fail institutions, banks are likely to curtail some lending too. This would lead to a further tightening of financial conditions. VC and tech companies and their founders and executives may find less understanding institutions than SVB reputedly was.
The second scenario could be a reticence by the Fed (and potentially other central banks) to continue on their aggressive policy path, particularly as impact of policy tends to arrive with a lag as we have seen. The sizeable collapse in the 2-year Treasury yield (-61bps, largest drop since Oct 1982) and the implied fed funds terminal rate (-80bps) suggests as much (Chart 1).
Chart 1: The Fed funds rate is now expected to peak in May, 80bps lower and four months earlier than last week
Source: Bloomberg, World Gold Council
*Based on implied Fed rate changes from the Fed fund rate futures’ market.
Third, digital currencies pegged to the US dollar are facing stronger regulatory scrutiny and cryptofirms may also struggle to access the US banking system as easily as in previous years following the failure of Signature over the weekend and Silvergate Bank a few days before.4
These three scenarios all look gold friendly. Tightening standards weakens the corporate and consumer sector and by extension the economy, inching the US closer to an official recession. Recessions have historically been good for gold. A lower ceiling for interest rates is gold friendly too, limiting the opportunity cost of holding gold. But a stalwart Fed possibly risks creating bigger problems down the line. Finally, concerns about systemic risks to bank deposits – whether warranted or not – may lead to investors moving some of their currency holdings into gold. A sign of this were the 16t (US$1bn) of inflows into global gold ETFs this week so far, reversing ten consecutive weeks of outflows.
Footnotes
1Financial Times, “History can instruct us on the fallout from SVB’s collapse”
2Thomson Reuters, “Silicon Valley Bank’s Failure Sparks Speculation that FASB Accounting Rules for Held-to-Maturity Debt Securities Should be Revised”
3Bloomberg Odd Lots, “Why interest rates on savings accounts are still so low”
4CNBC, “What the failures of Signature, SVB and Silvergate mean for the crypto sector”
What next for gold in a volatile bond market?
Jeremy De Pessemier
Asset Allocation Strategist World Gold CouncilFaced with banking troubles on both sides of the Atlantic as well as uncertainty surrounding inflation and central banks, markets have gone through a brutal few weeks in terms of interest rate volatility (Chart 1).
Chart 1: Interest rate volatility is on the rise again after breaking below the symbolic 100 level in the MOVE index in early February*
*As of 15 March 2023.
Source: Bloomberg, ICE BofA Move index, World Gold Council
Gold has been directly impacted by these recent moves in interest rates (Chart 2). First, a sequence of stronger-than-expected US economic data prints (payrolls and retail sales in particular) and a barrage of hawkish comments from US Federal Reserve speakers generated a meaningful repricing up of the Fed Funds rate trajectory, negatively impacting gold. Next, a sharp risk-off move – triggered by mounting financial stability fears after the collapse of Silicon Valley Bank, Signature Bank and Credit Suisse – sent peak Fed rates down again, propelling gold higher. In this process, the implicit peak of the rate cycle has shifted from October back to May 2023, which means that the market is now expecting the tightening cycle to end much sooner.
Chart 2: Gold price reacting to recent fluctuations in interest rates*
*As of 23 March 2023.
Source: Bloomberg, World Gold Council
What next for monetary policy and gold?
As it currently stands, how long the Fed will hold rates at elevated levels remains unknown. What is clear is that the Federal Open Market Committee is determined to avoid a replay of the 1970s and is under a lot of pressure to display an unwavering commitment to fighting inflation, even if, as some investors have suggested, its actions push the US economy into recession.
What is also clear is that getting inflation down to central banks’ 2% target is causing both economic and financial damage. The failure of two US regional banks and a major Swiss bank and the surge in UK government borrowing costs last year show that the effects of monetary tightening take time to filter through the economy and that the vulnerabilities associated with an aggressive tightening phase often show up in unexpected places. This will probably warrant caution on the part of the Fed, reinforcing our view that we may be closer to the peak of central bank hawkishness. This scenario would support gold particularly if accompanied by a mild recession – after all, a key issue over the coming months will be the extent to which the crisis of the past week causes banks to tighten credit (Chart 3). This in turn would weigh on consumer demand and business investment and therefore hurt growth.
Chart 3: US financial conditions have deteriorated suggesting availability and cost of credit have worsened*
*As of 20 March 2023.
Source: Bloomberg, Bloomberg United States Financial Conditions Index, World Gold Council
Long-term trends should continue to support gold
Looking along the investment horizon, it is also unlikely that gold will be met by headwinds from higher interest rates. There are risks to this outlook, of course, notably sticky inflation or bouts of inflation – due to long-term shifts in dynamics such as the clean energy transition or potential deglobalisation – which would keep Fed policy tight. That said, long-term structural indicators do continue to point to a low-growth, low-yield environment anchored by slow labour force growth and weak productivity growth (Chart 4).
Chart 4: Headwinds for trend growth continue to anchor real interest rates*
*Data from March 1957 to December 2022. Trend growth is the sum of long-term labour force growth and productivity growth. Labour force and productivity growth rates are 10-year annualised numbers.
Source: Bloomberg, Bureau of Labor Statistics, World Gold Council.
Moreover, debt levels also continue to be high, further constraining a strong growth environment. In fact, businesses, consumers and governments face increasing interest costs as a percentage of income, reducing expenditure and growth potential in the economy.
Demographics have also been trending downward for several decades and are expected to continue to do so in high-income countries (Chart 5). This is important as it determines the relative number of (net) savers and borrowers in the population of a country. Young people are generally borrowers. Middle-aged and elderly people are generally savers. An ageing population means that there are fewer opportunities for savers to deploy their savings. This creates a borrower’s market in which interest rates are pushed lower to encourage more borrowing.
Chart 5: People are living longer and having fewer children, leading to a greater proportion of elderly in the population*
* Data from 1960 to 2020. 2021 to 2050 are forecasts.
Source: The World Bank, World Gold Council.
In summary
Cyclical developments in growth and inflation will dominate the short-term outlook. And while it is likely that the Fed pricing moves back up again, especially if recent financial sector fears can be put in the rear-view mirror, investors should keep an eye out for a hint from the Fed that it is close to done. This could provide more support for gold.
Longer term, gold has a key role as a strategic long term investment and as a mainstay allocation in a well-diversified portfolio. While investors have been able to recognise much of gold’s value during times of market stress, the structural dynamics pointing towards a low-growth, low-yield environment should also be supportive for the precious metal.
Shunto, stagflation and gold
Ray Jia
Head of Research (Asia Pacific, ex-India) and Deputy Head of Trade Engagement (China) World Gold CouncilSummary
Japanese employees could see the biggest overall pay rise for 30 years
The 2023 “Shunto” sent positive signals to Japanese employees regarding possible pay increases amid a backdrop of elevated inflation in the region. Shunto – the wage negotiations between major corporations and unions that take place every March – provides pay level guidance for all Japanese employers, large and small. This year, the main labour unions and employers agreed on a 3.8% pay rise, the highest since 1993 (Chart 1). In addition, the basic wage will increase 2.3% this year, the highest increase since 2015, when Rengo, or the Japanese Trade Union Confederation, began to publish such data.
And while final Shunto results and actual pay rises across Japan may differ from the initial negotiations, the trend is clear: Japanese employees’ earnings are rising. The Fast Retailing Co. announced pay rises of up to 40% in January, and other enterprises including Nintendo, Toyota and Panasonic are giving their employees wage bumps not seen for years. 1
Chart 1: 2023 Shunto result sees the highest overall pay rise for 30 years
Source: Rengo, World Gold Council
Pay increases may alleviate some cost of living pain but they may contribute to sustained inflationary pressure
There is no doubt that these pay increases will help relieve pressure on local households from rapidly rising living costs. Japan’s core inflation grew at 3.5% y-o-y in February, the fastest since January 1982 (Chart 2). According to the Bank of Japan’s (BoJ) opinion survey, more and more households are feeling the current economic pressure and nearly 90% blamed high inflation; more than 50% felt that price levels have gone up significantly.
Chart 2: Japan’s inflation pressure remains elevated – local households feel the pain
Source: Bloomberg, World Gold Council
But higher wages could contribute to inflationary pressures in Japan. Our analysis finds that every 1% y-o-y increase in wages leads to a 0.1% rise in y-o-y CPI (Chart 3). And the former BoJ governor Kuroda also noted that a 3% wage increase would be needed for local inflation to sustainably rise above the target - although he didn’t clarify which type of wages. 2
Furthermore, supply-side inflationary pressures remain a concern, particularly as crude oil prices have rallied in the recent OPEC+ output cut 3 and over 90% of Japan’s energy resources rely on imports. 4
Chart 3: Wages positively impact inflation growth in Japan
Source: Bank of Japan, Bloomberg, World Gold Council
Stagflation risk is rising
Meanwhile, Japan’s economic recovery is facing challenges. For instance, the increasing risk of a global recession and systemic turmoil in the global financial sector, fuelled by the recent banking industry crisis, could weigh on Japan’s recovery as it is highly dependent on external demand. And the aforementioned wage rises, if not transmitted into sustainable economic growth, may intensify stagflationary risks.
This possibility of slower growth and rising inflation, or stagflationary pressure, is likely to make Japanese investors restless. After all, financial assets in Japan have performed poorly during past stagflationary times. But gold has outperformed all other major assets during stagflationary periods in Japan (Chart 4). These periods are typically characterised by heightened financial market volatilities, elevated inflation and sluggish growth that keeps interest rates low. All of these lay a foundation in which gold thrives.
Chart 4: Gold, in yen, thrives in various economic scenarios, one of which is stagflation*
Source: Bloomberg, World Gold Council
*Based on q-o-q changes in Japan CPI, GDP, LBMA Gold Price PM, Bloomberg Commodity Index, Bloomberg Barclay US Aggregate Index, MSCI World Index, Bloomberg Barclay Global Aggregate Index, Tokyo Stock Exchange Index and Nomura Bond Performance Index JGB between 1972 and 2022. All calculations are in yen.
Goldilocks: GDP up, CPI down; Reflation: GDP up, CPI up; Stagflation: GDP down, CPI up; Deflation: GDP down, CPI down.
Gold, in yen, has already outperformed major assets in Q1 2023 in the face of heightened concern around a possible global recession (Chart 5). Looking ahead, while recession may be inevitable, the risks mentioned above add further challenges to Japanese portfolios. Gold, a safe-haven asset with low correlation to risk, often rewards investors with superior returns and portfolio protection during such periods.
Chart 5: Gold, in yen, saw a 9% return in Q1 2023, outperforming major assets
Source: Bloomberg, World Gold Council
As of 31 March 2023.
Gold's Q1 performance told an interesting story as financial cracks began to appear
World Gold Council
The experts on goldWorld Gold Council
The experts on goldGlobal central bank gold reserves remained flat in March
Krishan Gopaul
Senior Analyst, EMEA World Gold Council• According to the IMF, 1 reported global central bank gold reserves remained virtually unchanged in March.
• Available data shows purchases almost perfectly offset sales, resulting in a net increase of 0.2 tonnes.
Central bank gold reserves virtually unchanged in March based on reported IMF data*
*Data as of 31 March 2023 where available.
Source: IMF IFS, respective central banks, World Gold Council
China reported its fifth consecutive increase to its gold reserves, adding 18 tonnes in March.
Reported PBoC gold reserves have now increased for five consecutive months*
*Data as of 31 March 2023 where available.
Source: IMF IFS, respective central banks, World Gold Council
Singapore followed with a reported increase of 17t, bringing its total reserves to 222t – 45% higher than at the end of 2022. In addition, India and the Czech Republic reported a more modest 4- and 2-tonne increase, respectively.
Reported sales of gold in March were driven primarily by Türkiye (15 tonnes), 2 Uzbekistan (11 tonnes) and Kazakhstan (10 tonnes). Türkiye sold the gold into the domestic market following a temporary partial ban on gold bullion imports. Further, it is not uncommon for central banks that purchase gold from domestic sources, such as Uzbekistan and Kazakhstan, to be frequent sellers of gold.
China and Singapore purchases helped offset heavy sales from Türkiye, Uzbekistan and Kazakhstan in March*
*Data as of 31 March 2023 where available.
Source: IMF IFS, respective central banks, World Gold Council
Russia also showed a 3 tonne fall in official gold reserves in March after submitting previously unreported information dating back to February 2022.
Stay tuned for our Gold Demand Trends Q1 report, to be published on 5 May, which will contain more detailed information on gold demand by central banks and other official institutions.3
Monthly changes in Central Bank of Russia gold reserves*
*Data as of 31 March 2023.
Source: IMF IFS, World Gold Council
Footnotes
1Based on IMF IFS data and supplemented with data from respective central banks where available and not reported through the IMF at the time of publication. IMF IFS data is reported with a two-month lag, and while most institutions report on a regular basis, some may report with a – sometimes significant – delay. Figures may be subsequently revised as more data becomes available. The data used here informs but is distinct from the central bank demand estimates we report in Gold Demand Trends. Please see footnote 3 for more information.
2Türkiye official sector gold reserves are the sum of central bank-owned gold and Treasury gold holdings. This is equivalent to gross gold reserves less all gold held at the central bank in relation to commercial sector gold policies (such as the Reserve Option Mechanism (ROM), collateral, deposits and swaps). For information on this methodology, see: Central Banks Methodology Note
3For purposes of Gold Demand Trends, central bank demand is defined as net purchases (i.e. gross purchases less gross sales) by central banks and other official sector institutions, including supra national entities such as the IMF and sovereign wealth funds where applicable. Our central bank demand data is sourced from Metals Focus, whose proprietary estimates of official sector activity incorporate various sources, including IMF IFS reports, international trade data, and others. As such, IMF IFS data is a subset of what is included in Gold Demand Trends. Both data sets are subject to revision as new information is made available and/or to accommodate late or updated data reported by official institutions.
Gold Gallups up the US long-term investment charts
Louise Street
Senior Markets Analyst World Gold CouncilThe latest Gallup Poll Social Series monitoring public opinion on economy and finance shows that gold jumped into second place as ‘best long-term investment’ in the US this year. 1
And here’s the kicker: while higher rates seem to have dampened investors’ perception of real estate as the best long-term investment (its share of the vote plunged from 45% to 34%), they haven’t damaged perceptions of gold. On the contrary, the number of Americans naming gold as the best long-term investment almost doubled this year from last. This, despite interest rates climbing to a 16-year high in March.
Over one quarter of US adults plumped for gold as their top choice in Gallup’s April poll, the highest for 11 years. This nicely echoes our data on US bar and coin investment: in our latest issue of Gold Demand Trends we reported that US investors bought 36 tonnes of gold bars and coins in Q1 this year, up sharply on the previous quarter.
One quarter of Americans view gold as the best long-term investment*
Source: Gallup
* Q: Which of the following do you think is the best long-term investment? Base: 1,013 US adults. Survey ran April 3-25 2023.
Our own research has shown a keen recognition of gold’s long-term value proposition and safe haven attributes in the US, with around two thirds of investors agreeing that ‘gold is a good safeguard against periods of political and economic uncertainty’ and that ‘the price of gold increases over time’. 2 Unsurprisingly, this conviction increases among those who have invested in gold: 87% of gold investors in the US agree that it holds its value over the long term. 3
Gold investors are keenly aware of its wealth protection and safe-haven potential
Source: Appinio, World Gold Council
* Q: Please indicate how much you agree or disagree with the following statements for why you invest in gold. Base: 1,095 gold investors.
Gold’s recent performance may have helped to bump it up the rankings. It’s interesting to note that the respondents who already own stocks have the lowest conviction in stocks than they’ve had since 2012: only 25% of stock owners view stocks at the best long-term investment. The same number (24%) think gold is better up to the task. This could be due to the relative performance of each over the past 12-18 months, with gold outshining the gloomy performance of US stocks.
And as US consumers raise their longer-term inflation expectations, gold’s historical performance as an inflation hedge may also be at play. According to the Gallup poll, conviction in savings accounts/cash deposits as a good long-term investment increased only slightly this year, even with cash deposit rates reaching 5%. But these rates are still quite poor in real terms and anyone expecting persistent inflation may be tempted more by the long-term investment proposition of gold than that of savings accounts. Our research shows that gold’s potential to ‘protect against inflation/currency fluctuations’ is well recognised among gold investors.
All in all, the survey results point towards Americans being familiar with gold’s potential for long-term wealth protection. Which is particularly valuable at a time when there are few – if any – dependable safe-havens also offering the potential for long-term returns.
Footnotes
1news.gallup.com/poll/505592/real-estate-lead-best-investment-shrinks-gold-rises.aspx
2The World Gold Council commissioned Hall & Partners to survey 10,000 retail investors across five markets US, Canada, Germany, India and China. Retail investors were defined as people who are aware of both gold and cryptocurrencies as an investment product, and who had made at least one investment (from a defined set of products) since the beginning of 2021. Online fieldwork was conducted in late October/early November 2021.
3Online survey of 2,000 US retail investors conducted via Appinio in late August/ early September 2022, targeting respondents who had invested in gold and/or cryptocurrencies in the prior 12 months. ‘Gold investors’ were defined as survey respondents who had ever invested in gold.
Inflation: A rare SMSF consideration
World Gold Council
The experts on goldSMSF investors continue to face inflationary pressure not seen in decades. And it could influence investment performance if the potential effects are not considered.
It has been more than 30 years since the Consumer Price Index (CPI) reached 7%1. The effects of rising inflation and subsequent central bank interest rate decision making were plain to see by the end of 2022. Having surprised markets by another 25bp hike in June, the RBA noted in their recent statement, that while inflation in Australia has passed its peak, it is still too high at 7% and that it will be some time before it is back within their target range of approximately 2%-3%2. And the governor noted upside risks to the inflation outlook has increased and “the path to achieving a soft landing remains a narrow one”.
Additionally, the vulnerability of global capital markets from negative shocks remain. The most recent example being the collapse Silicon Valley Bank (SVB), coupled with Credit Suisse a few days later. Investors started to call into question the stability of the banking industry which helped move gold over the US$2,000 level, and coupled with a weakening FX rate, gold recorded its highest ever price in Australian Dollars in early May3.
2022 and H1 2023 returns from major assets in Australian Dollars*
Source: Bloomberg, World Gold Council
*As of 31 December 2022. 2023 Y-t-d refers to 30 June 2023. Based on LBMA Gold Price PM, AusBond Bank Bill Index, AusBond 0+ Composite Index, Bloomberg Barclay Global Agg, ASX300 Index, MSCI World Index, ASX300 A-REIT Index, FTSE EPRA/NAREIT Developed ex-Australia Index, FTSE Developed Core Infrastructure Index. All calculations are in AUD.
Where could this lead?
With the upside risk to future inflation rising and local economic outlook dimming, the traditional warning signs of stagflation exist. Stagflation is defined as an economic cycle characterized by slow growth and a high unemployment rate accompanied by high inflation. The most notable period in Australia occurred in 1975 when a recession begun after the price of oil quadrupled.4
In addition, the global geopolitical landscape is potentially hindering economic recovery efforts worldwide. The ongoing situation in Ukraine, and tensions between the US and China, might continue to impact financial markets. Over the coming 18 months elections in the US and EU are scheduled. There is additionally the prospect of the UK, Russia and Ukraine going to the polls. All of these events pose risk to the fragility of the economy with some being higher than others.
What should an SMSF investor be considering?
Does your SMSF have enough protection over stubborn high inflation and other possible market events? While property is a stable long term inflationary hedge, it has had considerable setbacks over the past 24 months. Additionally, the sustained interest rises imposed by the RBA to combat inflation, may pose challenges Property is illiquid too meaning that while the long term return on investment will still remain positive, it cannot help to hedge portfolios in the short and/or medium term.
Another inflationary hedge asset, which is often overlooked by some SMSF investors is Gold. It has long been considered the hedge against inflation and market events. It can also provide accessible liquidity if and when needed. Historical data confirms its status with an annualised return of 7.6% in AUD over the past 20 years, it has outpaced the Australian and world CPIs even in calmer economic times5.
And should stagflation arise?
During stagflation periods, financial markets have seen heightened volatility while both commodities and gold fared well.6 Historical data reveals that investment portfolios have benefited from gold’s attractive returns during such periods.
As aforementioned potential risks arise, gold may have a significant role to play over the coming years to help protect and sustain portfolio performance. Our recently published investment update concluded that a portfolio comprising of assets typically held by an SMSF would have achieved higher risk-adjusted returns and lower drawdowns with an allocation to gold over a 3, 5, 10 and 20 year period.
At the very least, SMSF investors should review their existing investment strategy and ensure that it has the right protection over high inflationary pressures, and to gain a greater understanding how it could potentially perform should stagflation hit home or in the economies of interest.
Read our full investment update here.
Footnotes
1Consumer Price Index, Australia, March Quarter 2023 | Australian Bureau of Statistics (abs.gov.au)
2For more, see: Statement by Philip Lowe, Governor: Monetary Policy Decision | Media Releases | RBA
3Based on LBMA Gold Price PM in AUD. The highest was recorded on May 4, 2023, at AUD$3,052/oz.
4For more, see: 70 Years of Inflation in Australia | Australian Bureau of Statistics (abs.gov.au)
5For more, see: Gold Price Returns | Gold Prices | World Gold Council
6For more, see: Stagflation rears its ugly head | World Gold Council
What are the implications for gold as yields converge?
Jeremy De Pessemier
Asset Allocation Strategist World Gold CouncilA lot has been made of the convergence of yields for cash, bonds and equities (on an earnings yield basis), with the higher yield on offer in the cash space leading many investors to reassess their portfolio exposures (Chart 1).
Chart 1: Yield comparisons
Source: Bloomberg, World Gold Council. Global equities is MSCI World Index, UK corporate is Bloomberg Sterling Aggregate Corporate Index, and cash is UK Bank of England (BoE) Official Bank rate.
*Data from 31 December 2012 to 30 June 2023.
In fact, with cash yields offering compelling reward with little risk and with the balance of economic forces still appearing to be tilted against global capital markets, investors have been rushing into cash over recent months. And after years of unattractive yields, it is of course a welcome change to get some interest on defensive positions. That, however, is different to saying that holding cash today – on a long-term basis – is a no-brainer. Why? Cash yields still aren’t positive in real terms (Chart 2). In the late ’80s, ’90s and pre-Global Financial Crisis, high cash rates were associated with growing spending power. Today it’s not the case.
Chart 2: UK’s real interest rate
Source: Bloomberg, World Gold Council
*Data from 31 December 1988 to 30 June 2023.
Considering the above, rushing back to cash today – other than for tactical reasons – is not the obviously good idea it might at first appear to be. There is no certainty its purchasing power will actually hold up. So the key question of where to make long-term investments that can deliver positive real returns remains as relevant as ever, given the inflation outlook.
From an asset allocation perspective, investors should remember the longer-term historical record of equities, bonds and gold. Moreover, looking for historical guidance on which assets to hold shows the advantages of stretching your time horizon to increase certainty of achieving real returns (Chart 3).
Chart 3: Maximum and minimum real annualised returns over various investment horizons
Best and worst performance based on annualised real returns over a rolling 1-year, 5-year, 10-year and 20-year basis*
Source: Bloomberg, World Gold Council
*Data from 1972 to 2022. Computations based on y-o-y returns for each rolling window. Cash: Bank of England official bank rate. Hypothetical balanced portfolio: 60% equities (FTSE 100 Total Return index), 40% bonds (ICE BofA UK gilts Index). Hypothetical balanced portfolio with gold: 60% equities (FTSE 100 Total Return index), 35% bonds (ICE BofA UK gilts Index), and 5% gold (LBMA gold price).
Retrospectively, as one moves up the investment horizon, the range of outcomes narrows – even for a balanced portfolio, which is traditionally categorised as riskier than cash. In fact, our analysis shows that the risk-reward profile of a balanced portfolio with gold starts to look attractive relative to cash (as well as a balanced portfolio without gold) after five years. And over any single rolling 10-year period between 1972 and 2022, the worst real return for a balanced portfolio with gold is better compared to both cash and a balanced portfolio without gold. This demonstrates the advantages of focusing on long-term investments and gold’s diversification and return attributes.
If one stretches the investment horizon further, both balanced portfolios (with and without gold) have the added benefit of always delivering positive real returns over any single 20-year period over the past five decades. By contrast, cash does not, highlighting that long-term overweight cash allocations may come with opportunity costs.
In summary, our analysis shows that good investment outcomes over a medium- to long-term horizon come from good strategic decisions. Chart 3 underscores why we believe gold has a key role as a strategic long-term investment and as a mainstay allocation in a well-diversified portfolio, alongside equities and bonds.
More on market perspectives: Gold Mid-year outlook 2023: Between a soft and a hard place