Risk off, fear on; the outlook for gold improves. Gold price breached the key USD2000/oz. price in April, driven by a flight to safety on the back of two global risk events: i) banking collapses in US and Europe, and ii) surprise production cuts by OPEC+ amounting to 1.15mmbpd. But beyond a fear-driven spike in demand, we believe that these events have also impacted gold demand in a more fundamental and lasting way.

The banking sector debacle for example is set to benefit gold demand through a more benign interest rate outlook; with the Fed now forced to balance financial market stability with its two existing mandates, it will likely have to abandon plans to further aggressive hiking, which will in turn weaken the dollar and keep a lid on treasury yields in the long run.

On the other hand, the surprise cuts by OPEC+ further cemented the likelihood of future scenarios dominated by either sticky inflation or mounting recession risks, both of which are favourable for gold, which is seen as both a safe haven asset and inflation hedge. Put simply, these recent developments have had a double-barreled positive impact on gold, skewing its return to the upside. Heightened fear stoked short-medium term inflows while a moderating rate/dollar outlook, rising growth risks, and sticky inflation bolstered the long-term demand outlook for the precious metal. Against this backdrop, we upgrade our outlook for gold and lift the target price from USD1,950/oz. to USD2,050/oz.

Dollar correlation holds. We mentioned in our quarterly CIO insights that gold price is very much dollar driven, and this has not changed. In January, the prospects of a US soft-landing and led to a softening dollar, which fueled a month of strong performance for gold. In February however, a spate of overly strong US macroeconomic data quickly changed the rate narrative to “higher for longer” and reversed much of the gains from the previous month.

Now, in the wake of Silicon Valley Bank’s (SVB) collapse, the rate and dollar outlook has once again shifted to one that incorporates rate cuts happening sooner rather than later. Since the crisis, the terminal rate pricing has been shaved by some 75-100 bps, and additionally, the market is now pricing in about 70 bps of cuts (from peak) by the end of the year and a cumulative 200 bps of cuts by end-2024. This rate outlook has sent the dollar on a steady decline since mid-March, while gold conversely rallied to a high of USD2,040/oz. on 13 April. Should there be further tremors in the banking sector, rate cuts could materialise, spelling further upside for gold this year.

Figure 1: Gold price rallied as risk events took centre stage and dollar weakened in March

Source: Bloomberg, DBS

Recession or inflation? Gold wins either way. While the banking crisis has so far been quite well-contained thanks to supportive policies from regulators, it does not change the fact that interest rates, at their current level, are impacting the real economy and nudging it closer to recession. The probability of recession has since risen from less than 10% in June 2022 to 60% as at the end of March this year. In an unlikely scenario where the US economy manages to stave off recession, the inference is that the inflation rate would remain elevated. Gold will still be a beneficiary as historical trends have pointed to gold as a good inflation hedge.

Other tailwinds wait in the hangar. Notwithstanding the latest price rally, we believe that there are further tailwinds for gold that have yet to be priced in. Among those are: i) growing central bank buying on the back of geopolitical reasons; ii) ETF flows, which have been largely missing from the most recent gold rally; iii) other forms of speculative buying in gold and gold derivatives; and iv) retail investor demand for gold. Even if gold’s current price has adequately priced in the current state of heightened market fear and growing recession risks (which we do not believe has been done), each of these factors represent further catalysts for positive price action for gold in the future.

Upgrade outlook for gold with target price of USD2,050/oz. Primary tailwinds for this upgrade are the sharp rise in recession probability; in our model we have used an 80% chance of US recession as a key assumption to arrive at our target price. We also expect: i) headline CPI at 5.0%; ii) DXY Index to weaken further to the 95-100 range, and 10Y US treasury yields to be between 3.0 – 3.5% for our target price to materialise. As mentioned, further upside price risks exist should the Fed decide to implement rate cuts in 2H. In such a scenario, a further revision of our target price will be warranted. For gold prices to push sustainably above USD2,050/oz., an unexpected and significant change in outlook for either inflation, treasury yields, the dollar or recession probability will have to take place.

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