Fundamental Drivers Align but Real Rates Pose a Threat

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Gold Review in a Year of Conflicts and Banking Stress

Gold showed just how volatile it can be throughout 2023. The precious metal declined as the dollar and Treasury yields rose in Q3 but reversed course in Q4 when the greenback and yields turned sharply lower. Gold also revealed its allure as a safe-haven asset during the banking turmoil in March as well as the early days of the Israel-Hamas war, seeing the commodity eventually obliterate the previous all-time high.

Expectations heading into Q1 2024 is for US growth to moderate and for inflation to record further progress, putting pressure on the Fed to cut elevated interest rates. Overall, the fundamental landscape favours bullish potential or at the very least, appears supportive of precious metals.

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Weaker USD and Declining Treasury Yields to Support Gold/Silver

Silver and gold tend to move in the same direction and respond to similar developments/fundamentals hence, the remainder of this article delves into topics that relate to both precious metals.

Gold inherently has an inverse relationship with US Treasury yields as well as the US dollar. When the dollar weakens this stimulates gold purchases for foreign buyers and since gold offers no yield, the metal gains in attractiveness whenever yields drop as the opportunity cost for holding gold declines.

Despite the Fed maintaining the possibility of another rate hike, markets have decided that the pathway for the Fed funds rate is to the downside. This is portrayed via the sharp drop in Treasury yields and the subsequent move lower in the dollar but also derived from implied rate cut probabilities from the Fed funds futures market. The chart below reveals how far gold prices have risen while USD and yields have fallen. Therefore, even if gold prices were to stall, the lower trend in yields and USD are likely to keep XAU/USD prices supported at the very least.

Spot Gold Price (gold line) with DXY (green) and US 10-Year Yield (blue) Overlayed

Source: TradingView, Prepared by Richard Snow

The broader commodity complex is showing signs of recovery after months of a general decline. A lower US dollar and the prospect of interest rates being drawn back faster than the Fed anticipated, has provided a lift for the sector. This is according to the Bloomberg Commodity Index which is a broadly diversified index distributed by Bloomberg tracking futures contracts on physical commodities. The combined weighting of gold and silver prices constitutes around 20% of the index meaning precious metal prices maintain a notable representation within the overall calculation.

Bloomberg Commodity Index 2023 Showing Early Signs of a Recovery

Source: Refinitiv, Bloomberg, Prepared by Richard Snow

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Gold’s Allure as a Safe Haven May Add to Existing Tailwinds

We saw in March and early October how sensitive gold is to systemic and geopolitical threats. In March there was the very real possibility of a banking crisis and in October the conflict surrounding Israel and Hamas resulted in war. In 2024 market participants will need to keep tabs on developments between China and Taiwan but also the growing tensions between North Korea and Japan, South Korea and the US.

Real Yields May Pose a Risk to the Outlook

One of the risks to a bullish outlook for gold throughout Q1 is the prospect that the Fed funds rate remains above 5% while inflation heads lower. Such an outcome raises real yields (nominal interest rate – inflation), which could draw capital away from the non-yielding gold and silver in favour of money market alternatives.