There are several signals of declining output as a result of the quick and aggressive hikes by the central banks. Global purchasing manager indices (PMI), which are currently in the contraction territory, reflect a global slowdown that is spreading across geographies, according to a World Gold Council Gold Outlook 2023.
The Road Ahead
No central bank wants to lose control of inflationary expectations, hence the banks will be focusing more on how to tackle inflation, rather than growth preservation.
“As a result, we expect monetary policy to remain tight until at least mid-year,” WGC said in the report.
Gold, on the other hand, has the potential to provide a hedge, as it fares well during recession. It has given good returns in five of the previous seven recessions.
The dynamics that were in play in 2022—high retail investment demand, but low institutional demand—could be partially reversed in 2023, the report said. Indeed, any indication that yields are declining could spur increased institutional interest in gold. Overall though, decreased inflation should result in somewhat less demand for gold from an inflation-hedging standpoint, the report added.
Bonds And Gold Correlation
According to the report, the yield curve (10-year US Treasury yield) has already reached its highest level of inversion since 1981. The long-end already appears to have factored in a recession, and additional inversion looks improbable.
So, both risk and term premiums are likely to be greater, placing pressure on long-term yields that will not change. The first of these comes from a higher bond-equity connection and increased supply in the latter – both by issuance and tightening the money supply, the report said.
“As gold has a stronger correlation to 10-year than shorter-term yields, we see less of a rates-driven benefit to gold in 2023,” WGC said in the report.
The report further said that equities are likely to experience more volatility if 2023 brings about a modest recession. Also, given the deteriorating macroeconomic environment and what earnings normally do during recessions, current consensus EPS expectations look conspicuously resilient.
In Case Of A Severe Recession
Given the lag in policy implementation in the economy, hyper-vigilant central banks run the risk of overtightening, which might have more severe economic consequences and can lead to conditions of stagflation, WGC said.
“Drops in profitability and business confidence might result in layoffs, which would considerably increase unemployment. Earnings would be severely impacted, and demand for gold and the dollar as safe havens would increase, making this a very difficult scenario for stocks,” the report said.
According to the report, a “soft landing” scenario, in which corporate confidence is restored and expenditure picks up, also presents downside risks for gold.
Bond yields would certainly continue high, and risk assets would likely gain, creating a difficult situation for gold.
“Strength in income-driven consumer demand would be offset by weaker institutional investment. Some retail investment could abate on higher confidence, but lingering inflation would unlikely result in a material drop. The case for a soft landing hinges largely on hard economic data not yet confirming the case presented by soft economic data,” World Gold Council further said in the report.