Three key ingredients are necessary for a vibrant gold bull market, and they’re beginning to line up as we head further into 2023. The last time these factors aligned—during the turbulent years of 2002-2009—gold had one of its best long-term performances in decades.
Each of these three catalysts individually is essential for gold prices to levitate, but when all three occur simultaneously, gold comes into its own and typically outperforms even the equity market. With this in mind, let’s take a look at the three main reasons that argue for gold market strength this year and beyond.
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Gold Catalyst #1: Financial Market Fears
It has been observed that fear is gold’s best friend, and in the wake of the SVB banking crisis, investors are becoming increasingly nervous, if not outright afraid, of the financial market outlook.
It’s not surprising then that on the day Silicon Valley Bank was shut down last week by regulators, gold prices jumped over 2% even as the Nasdaq and other major indexes fell by about the same percentage. Fear was everywhere, and the first reaction of investors was to rush to the yellow metal as a protection against financial uncertainty.
As SVB customers lined up in the wake of the bank’s shutdown to withdraw their money, market pundits published a slew of articles conjuring memories of the 2008 credit crisis and suggested that perhaps another such event may be imminent.
But regardless of whether or not the SVB crisis spills over into the broader financial market, memories of the past credit crisis are still relatively fresh in investors’ minds, making it all but certain gold will have built-in support as a hedge against higher volatility.
Gold Catalyst #2: Lingering Inflation Pressures
Heading into 2023, a number of economists predicted that this would be the year inflation began to wane. The main piece of evidence they offered was the dramatic and historic reversal in the yearly growth rate of the M2 money supply.
However, what was apparently forgotten in the discussion is that inflation has two main components: 1.) supply of money, and 2.) availability of goods. While it’s true that inflation is primarily a monetary phenomenon, a shrinking availability of goods—and the labor used to create them—can by itself put upward pressure on consumer prices. This is an issue facing the economy right now.
Last year, the IMF published a paper highlighting China’s “declining business dynamism,” arguing that China (the world’s biggest manufacturing powerhouse) is seeing a steady decline in its productivity. The IMF pointed to structural issues, including a shrinking labor pool related to a demographic decline, as a key reason behind the drop in productivity.
Here in the U.S., worker productivity has also been called into question as “large shifts in the composition of the workforce in the wake of the pandemic have made it harder to get a clear read of productivity,” in the words of a recent Reuters article. What’s more, a trend toward “burned out” workers seeking out more part-time jobs—and fewer hours of work—suggests lower levels of economic output may lie ahead.
Another reason for expecting inflation to persist in 2023 is the phenomenon known as “cost-push,” which involves rising wages and higher prices for the commodities used to make goods. One reason why consumer prices didn’t spiral out of control last year was the relentless strength in the U.S. dollar index.
But with the dollar now in a weaker position, commodity prices are likely to remain buoyant in the coming months. And this could mean that currently high retail food and fuel prices won’t diminish anytime soon.
Gold Catalyst #3: Dollar’s Waning Dominance
China has drastically reduced its holdings of U.S. Treasury debt (which recently fell under $1 trillion for the first time since 2010), while also embarking on an effort to unload dollars in order to stabilize its own currency.
Elsewhere, Egypt’s government has been issuing debt denominated in China’s currency as an alternative to the higher borrowing costs associated with the U.S. dollar.
Iran is advocating for the establishment of a joint bank with African states in order to promote trade in local currencies. The move would allow Iran to move away from using the U.S. dollar in foreign trade transactions.
Meanwhile, Sudan is the latest in a growing list of nations reportedly seeking to ditch the dollar in order to trade with Russia.
While the dollar reserves of many countries are shrinking, gold reserves are increasing as a shift seems to be underway from using the dollar as a preferred safe haven to that of gold. A World Gold Council (WGC) report found that 80% of the 57 central banks it surveyed plan to increase their holdings of the metal in the coming year. Indeed, 2022 was the biggest year ever for central bank gold demand.
Moreover, some 42% of central banks surveyed anticipated the greenback would diminish as a portion of total reserves in the next five years due to loss of confidence in the dollar as a reserve currency.
All told, as the dollar’s dominance in world trade diminishes, gold’s importance will increase, providing the metal with strong support for years to come.
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