High interest rates, strong dollar among main headwinds for gold; physical demand for silver may increase in FY23

By Naveen Mathur

Last year, spot gold saw approx. However, losses of 3.6% hit around $1,937 per ounce in the past three months and posted a quarterly gain of 5.9%, the highest in the three months to September 2020. There had some catalysts for the rally. The Russian-Ukrainian conflict as well as global growth concerns boosted the appeal of safe havens.

Source: Bloomberg

Inflation: getting hotter

U.S. consumer price inflation accelerated in February to a new 40-year high on rising gasoline, food and housing prices, with inflation on the about to increase even more after the invasion of Ukraine by Russia. Fed officials could take a more hawkish stance if energy shocks lead to higher and more persistent inflation, but they could also take a more cautious approach if falling consumer sentiment and falling real wages start to weigh on growth as the war drags on.

Source: Bloomberg

The Federal Reserve has announced it will reduce its huge bond holdings at a maximum rate of $95 billion a month, further tightening credit across the economy as the central bank raises interest rates to calm the highest inflation in four decades. Many Fed officials preferred 50 basis points at the March monetary policy meeting.

The performance of gold is linked to investments

The behavior of gold prices was linked to the demand for investment, in particular gold ETFs. Gold’s performance was also linked to jewelry, technology and central banks. We believe that gold can still receive positive support in 2022 from major jewelry markets, such as India.

Source: Bloomberg

Finally, central bank demand for gold could remain an important source of demand. There are good reasons why central banks favor gold as part of their foreign exchange reserves which, combined with the low interest rate environment, continue to make gold attractive.

Short Outlook: Gold’s Performance Will Depend on the Factors Driving the Market

In our view, gold will likely face some of the key headwinds in 2022: higher interest rates, the Fed’s balance sheet reduction plan, and a potentially stronger dollar. However, the negative effect of these drivers may be offset by other supporting factors, including: persistently high inflation, an inverted bond yield curve – a possible recession trigger, market volatility related to Covid-19 , geopolitics, etc. sectors such as central banks and jewelry will drive the trend. However, a further slowdown in the Chinese economy may limit the contribution of local demand for gold jewelry.

Against this backdrop, gold’s performance in 2022 will ultimately be determined by the factors driving the market. Yet the suitability of gold as a risk hedge will be particularly relevant to investors this year. Comex gold could drop to $1,870 an ounce in case $1,910 is broken with volume support. MCX Gold June could drop to 50,500 rupees per 10 grams in the coming weeks.

Silver: Rallies on Escalating Geopolitical Risk

Source: Bloomberg

Spot silver nevertheless slipped more than 11% in 2021, in the first quarter of 2022 it rebounded 6.39%, closing comfortably at $24.78 an ounce amid rising industrial demand and of investment. Silver had followed the price of gold – and indeed that of most precious metals – higher as Russian forces invaded Ukraine and investors sought safer havens.

Silver Institute: Global demand expected to increase by 8% in 2022

The rapid expansion of renewable energy as governments around the world increasingly commit to reducing carbon emissions is expected to drive demand for silver for solar photovoltaic panels to an all-time high. Physical demand is expected to increase this year, which could support spot prices. The Silver Institute predicted that global demand could increase by 8% from 2021 to reach an all-time high of 1.112 billion ounces in 2022.

Investment demand for physical silver bars and bullion coins is expected to jump 13% in 2022 to a seven-year high. Demand for silver for jewelry is expected to increase by 11%. Silverware demand is expected to increase by 21%.

Insights: Physical Demand to Support Sentiment

Continued macroeconomic uncertainty and high inflation are prompting retail investors to increase their exposure to silver as a hedge and store of value and to limit profit taking. However, once the pace of U.S. policy rate hikes becomes more evident, the price outlook becomes more challenging.

In the medium to long term, uncertainty should continue to dominate the headlines, with dollar strength expected but not able to limit silver’s gains. If Russian energy and food supplies are interrupted and world prices explode, inflation expectations in the market should finally ignite bullion, including silver for major upside extensions. MCX Silver May is expected to rise further to Rs. 68,500 per kg in the coming weeks.

(Naveen Mathur is Director, Commodities and Currencies, Anand Rathi Shares and Stock Brokers. Opinions expressed are those of the author.)

Leslie M. Gill