investment viewpoints

How shiny does gold look when anticipating a soft landing?

How shiny does gold look when anticipating a soft landing?
Didier Rabattu - CIO, Sustainability Equities

Didier Rabattu

CIO, Sustainability Equities
Florian Ielpo, PhD - Head of Macro, Multi Asset

Florian Ielpo, PhD

Head of Macro, Multi Asset



Need to know

  • In 2022, gold was probably the commodity that disappointed investors the most
  • This was due to real rates rising rapidly, but this factor may now be behind us
  • Looking at gold's historical sensitivities puts the precious metal in a good position, especially if the expected soft-landing scenario turns into a stagflation or a hard landing


Where next for gold pricing?

Since 2022, many of the doubts about using commodities as a source of diversification have been dispelled, after years of underperformance - a 'decade for nothing' in these markets, between technological evolutions and geopolitical developments.

While most commodities played a role as inflation dampeners in 2022, one commodity clearly lagged: gold and precious metals in general. Gold generally reacts positively to four main factors: rising (US) inflation, a falling dollar, falling real rates, and rising risk aversion. In 2022, gold performed close to zero, as the dollar appreciated on the back of rising real rates. These two factors were offset by an increase in risk aversion and higher inflation.

This year has seen gold prices rise by more than 8% as inflation has remained strong, but the rest of the factors have stabilised: is the catch-up from the frustrations of 2022 behind us? Risk aversion of an unpredictable nature aside, measuring the sensitivity of the yellow metal to changes in real rates and inflation has become essential in order to form a scenario for its price evolution. Let's take a closer look at these elements.


Inflation everywhere

Gold has a relationship with long-term inflation that was documented fairly early on in the academic literature. Claude Erb and Campbell Harvey reported the details of this relationship in their 2017 article The Golden Constant. The idea behind this relationship is that the purchasing power of gold over the long term should remain stable: when inflation is high, its price should adjust, thus hedging its holders against the effect of inflation.

The performance of the yellow metal this year probably derives a significant part of its broad return from reacting positively to US prices. Figure 1 shows a reproduction of Erb and Harvey’s research, which we updated in April 2023. The long-run relationship remains, but when the latest values of gold are plotted against its long-run relationship with US inflation, gold stands above it. In other words, gold entered the 2022 inflation shock already well above its fair value: its lack of response to the ’wall of inflation‘ that the US and the world faced is probably rooted in this initial overvaluation.

Figure 1 also allows us to judge the evolution of this relationship over a few sub-periods which we also believe to be meaningful to understanding today's situation. Gold has outperformed its price relationship on two historical occasions: during the stagflation of 1971-1981 and during the quantitative easing boom of 2008-2010. While quantitative easing today appears to be settled, stagflation is far from it. Gold is therefore expensive from the point of view of current inflation, but if this inflation remains stickier than expected, its valuation could nevertheless rise. This holds true if the second of the major factors under consideration here does not run amok: real rates.


Figure 1: Historical relationship between the US price level and the gold price

Source : Bloomberg, LOIM


Gold's Achilles heel: real rates

This "golden constant" linking gold and inflation is regularly disrupted by a headwind: real rates. The difference between nominal rates and inflation compensation plays an essential role in the performance of gold. Gold is a currency that does not pay interest rates (just like crypto-currencies) and it trades against the dollar that pays interest to its holders. The real price of gold must therefore decline if US real rates rise, as the opportunity cost of holding gold versus the dollar increases. This is illustrated in figure 2: historically, gold returns are a decreasing function of real rates.

When we consider the strength of this relationship over different historical periods, we draw some interesting conclusions. While gold has recently tended to under-react to changes in real rates, in the period 1971-1981 this sensitivity was a lot more pronounced (the slope of the trend line in figure 2 is more negative). This is a message of caution: the risk to gold holders today is that real rates will rise more than expected. On the contrary, a fall in real rates due to a ’hard landing’ could well benefit gold investors. The role of the Federal Reserve is crucial here: a Fed that pivots is a Fed that would push the price of gold higher.


Figure 2: Historical relationship between changes in US 10-year real rates and one-year gold returns

Source : Bloomberg, LOIM


One scenario and three risks

By regressing gold prices on its two fundamentals (price level and real rates) over the period 1972-2023, a fundamental valuation can be derived from this historical relationship. Figure 3 illustrates how how rising inflation and falling real rates between 2020 and 2021 pushed up the fundamental valuation, before that fundamental value finally rejoined gold's market price. Gold had somehow pre-empted both of these phenomena between the Fed's 2019 pivot and the entry into the pandemic. More recently, rising real rates have taken the fundamental valuation from 1870 to 1520, a decline of over 18%. The price of gold has been volatile but trendless over this same period, seemingly pointing to the idea that rising real rates are temporary while inflation is less so.

From this relationship, different scenarios can be conjectured to help the investor understand what kind of return to expect in which scenario.


Figure 3. Gold price and its fundamental value derived from the US price level and real rates

Source : Bloomberg, LOIM


Figure 4 shows the breakdown of scenarios we consider. The current soft-landing scenario combines an economic slowdown with a normalisation of inflation. In such a scenario, our previous analysis points to a gold performance of 3% (close to its long run performance per year). To this scenario, the chart adds three risks: an inflationary scenario, with a tolerant Fed and unchanged real rates that pushes gold's return to 7%. A stagflation scenario (high inflation and nominal rates rising slower than inflation) would see gold deliver a return of almost 13%. Only a very aggressive fight by the central bank against inflation would hurt gold prices. In such a scenario, gold would deliver a near-zero performance.

These different risk scenarios seem to make of gold an attractive asset as a hedge against the median market scenario - an asset not to be ignored these days, seeing how widely accepted the soft-landing scenario is.


Figure 4: One-year performance scenario for gold based on US inflation and real rates

Source : Bloomberg, LOIM

Reading note: “Inf” stands for inflation and “RR” for real rates.

  Simply put, gold underperformed in 2022, but the risks involved in a soft-landing scenario could see its price rise. Gold could look very shiny in 2023.  


Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises and global monetary policy surprises designed to track the recent progression of macroeconomic factors driving the markets. 

Our nowcasting indicators currently show:

  • The growth situation remains unchanged, only trends are getting exacerbated: slower growth in the US, resilience in the Eurozone and China continuing its recovery – with jaw-dropping 80% of improving data over the month
  • As in the case of growth, our inflation indicator hides beneath its surface an important message in terms of diffusion index: in the US, the percentage of increasing data has moved from 39% at the beginning of the month to 60% today. Not the kind of message the Fed will be happy with
  • Our monetary policy indicator continues to expect moderation from our central banks – not a pivot. With the recent inflation message, that moderation is unlikely to change now

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Reading note: LOIM's nowcasting indicators gather economic indicators in a point-in-time fashion to measure the probability of a given macroeconomic risk - growth, inflation and monetary policy surprises. The Nowcaster ranges from 0% (low growth, low inflation and dovish monetary policy) to 100% (high growth, high inflation and hawkish monetary policy).

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