- Tuesday, May 07, 2024
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Gold prices experienced a less than stellar performance in 2021, dropping approximately 3% during the year. Part of the reason for the decline was the rally in the U.S. dollar. Since gold prices are quoted worldwide in U.S. dollars, a stronger greenback generally lowers gold prices. The strength in the dollar comes from higher U.S. yields relative to European yields, which has driven the interest rate differential in favor of the U.S. currency. The question for gold traders is, can commodity trading of gold outperform in 2022 relative to its performance in 2021? If the Euro starts to exceed the greenback’s performance, then gold prices should be able to notch up a better performance in 2022 than in 2021. Additionally, gold prices have been trading sideways for about 18 months. The commodity trading pattern that gold prices are forming is a flag pattern poised to break to one side or another.
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The Last Strong Gold Performance
Gold prices saw robust gains in 2019. It was the strongest year over performance for the yellow metal since 2010. Some of the initial drivers included a weak U.S. dollar, declining treasury yields, and the potential for declining growth. Additionally, there was the feeling that dovish central banks around the globe would create demand for an alternative to paper currency, helping to buoy the yellow metal. Compounding these returns was a huge influx into gold exchange-traded funds (ETFs), which saw the highest inflows since the 2016 Brexit vote in the U.K.
The 2021 Marco Backdrop
The macro backdrop in 2021 was unkind to gold. The uncertainty of the pandemic in 2020, which led to higher gold prices in Q1 of 2020, was replaced by the hope that vaccines would bring life activities back to normal. The whipsaw price action left gold in a consolidative tone in 2021. In October 2021, the markets started to believe that the U.S. Federal Reserve would begin to unwind its bond purchase program. In November of 2021, the Federal Reserve announced that it would reduce the volumes of Treasury and Agency bonds it had purchased to ease monetary policy accommodation. Commodity trading started to come under pressure during this period, as Treasury yields began to climb. In December of 2021, Treasury yields hit pre-pandemic levels, as the Fed signaled that it could begin to tighten short-term interest rates. The markets are now pricing in between four and five, 25 basis point interest rate hikes in 2022. Goldman Sachs sees five hikes and some analysts see seven interest rate hikes. The market is pricing in at least four interest rate hikes. If inflation and growth start to moderate, the jawboning the Fed has undertaken has helped the market do the Fed’s job. Higher treasury yields have also helped the dollar gain traction, making life difficult for gold prices.
More Inflation in the EU Could Mean Higher Rates
One of the issues has been that there has been little inflation in Europe and little concern that the ECB would increase rates. In the first week of February, Eurozone inflation surprised the market. The main EU inflation gauge rose to 5.1%, a new high. Expectations were for a decline. The critical driver was energy prices, which have been experiencing upward pressure. Month over month inflation was increased to 0.3%. The substantial gains in EU inflation lifted EU interest rates. The higher level of rates in the European Union helped the Euro gain traction against the U.S. dollar. With energy prices likely to remain elevated, inflation will likely remain strong in the EU and potentially change the interest rates policy of the European Central Bank.
Gold prices could benefit if the Euro rebounds versus the U.S. dollar. The combination of higher European yields and potentially lower U.S. growth could help gold prices. In January, ADP reported that U.S. companies unexpectedly reduced job hiring by 301,000 jobs. Some of this news was due to the spread of the omicron variant of COVID-19, and some of it was due to the timing, but the upshot was that job growth slowed. Since the Fed has a dual mandate of maximum employment and price stability, the decline in employment might keep the Fed on hold. If inflation in Europe keeps rising, the ECB could put the breaks in further accommodation since the ECB has a single mandate of price stability. If these two phenomena continue throughout 2022, the Euro will outperform the dollar, and gold prices could exceed in 2022 relative to its returns in 2021.
The Bottom Line
The upshot is that commodity trading in gold could outperform the returns experienced in 2021 in 2022. Higher inflation rates in the EU and potentially lower growth in the U.S. could be the combination of events that help gold prices gain traction. U.S. treasury rates might have overshot their appropriate levels, which could be the bright spot in 2022 for the yellow metal.
