Fear-induced demand is driving up gold prices, Goldman Sachs says

Growing contagion risk in the banking industry and prospects of an imminent US recession are stoking the rally, experts say

The turmoil in the global banking sector has raised risk and driven gold prices above $2,000 a troy ounce for the first time since March 2020. Reuters
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The sharp increase in gold prices — by $150 per troy ounce — over the past two weeks has been driven by an increase in fear-related demand, according to a report by Goldman Sachs.

The price of gold has risen to levels not registered since March 2020, on the back of banking and funding stress and a sharp rise in the market-implied probability of a US recession next year, the investment bank said.

“The speed at which markets repriced a Fed pivot from 100-basis-point tightening to 50 bps in rate cuts by year-end has been unprecedented, leading to a spike in rates volatility to levels last seen in the depth of the 2008 financial crisis,” the report said.

“During the sell-off, gold outperformed risk assets such as equities or credit, turning it into an effective hedge in the risk-off rotation. Cyclical commodities like oil and base metals fell sharply.”

The US Federal Reserve raised interest rates by a quarter of a percentage point on March 22 after policymakers were faced with a banking crisis and elevated inflation.

Earlier this month, Fed chairman Jerome Powell suggested that policymakers would probably return to aggressive rate rises, but the collapse of Silicon Valley Bank and contagion fears ended that plan.

Financial markets are also facing escalating volatility despite the news that Swiss bank UBS would acquire Credit Suisse, resulting in risk appetite being sucked from markets.

The continuing turmoil in the banking sector has raised risk while the flight to safety amid the doom and gloom resulted in gold — a traditional safe haven — surpassing $2,000 a troy ounce for the first time since March 2022, when Russia invaded Ukraine.

The rally in gold prices is being fuelled partly by fears of growing contagion risk in the banking industry, as well as fundamental driving forces, according to Vijay Valecha, chief investment officer at Century Financial.

“The recent turmoil inflicting US and European banks roiled global markets. A risk-off sentiment has permeated the markets in its aftermath as investors wait for further clues about the extent of the crisis,” he said.

Although a full-blown global banking crisis appears unlikely given the support from other lenders, regulators and central banks, cautious investors are flocking to bullion for its safe-haven appeal.

“The collapse of Silicon Valley Bank and Credit Suisse, not to mention the smaller regional US bank failures, saw gold benefit from safe-haven demand as fears grew concerning the stability of the global financial system as a whole, with genuine concerns being expressed that we were potentially facing another Lehman Brothers moment,” said Stuart Cole, head macroeconomist at Equiti Capital.

“The clear signal that the rise in the gold price was fear-driven was then confirmed by the retracement we saw following the rescue of Credit Suisse and the general easing in worries over the financial system, as central banks took rapid action to shore up sentiment.”

Risk appetite picked up again and, combined with a rise in bond yields, demand for gold softened once more.

“Furthermore, the Fed is showing signs of approaching close to the end of its rate hiking cycle,” Mr Valecha said.

“Expectations of an eventual pause or pivot are driving prices of the non-interest-bearing bullion upwards.”

Risk-aversion on the back of US Treasury Secretary Janet Yellen’s comments on the government not considering blanket insurance for bank deposits is also supporting gold prices, said Craig Erlam, senior market analyst for the UK, Europe, the Middle East and Africa at Oanda.

The possibility of an imminent recession, the decline in the US dollar and Treasury yields, and the reopening of China's economy are also lending support to gold prices.

All these factors are responsible for the 8 per cent rally in gold prices so far this year, Mr Valecha said.

Gold has effectively outperformed all other asset classes this year. It surpassed the crucial $2,000 mark on March 20 due to the trouble brewing in the banking industry, Mr Valecha said.

“Since gold prices are quite elevated already, any corrections between 3 per cent and 5 per cent would present a good opportunity to invest in bullion,” he added.

Gold has traditionally been a hedge against recession for risk-averse investors, Mr Cole said.

In periods of negative growth, when investment returns are low and interest rates closer to zero, investors will typically turn to gold as an alternative investment product and store of value, he said.

“Gold deposits earn no interest, so gold becomes increasingly attractive as real returns move lower. This is why the price of gold has been on an upwards trend despite the rises in global interest rates — the real rate of interest remains negative,” Mr Cole said.

“As rates of inflation lower and interest rates move back into positive real territory, demand for gold, and its price, can be expected to soften.”

Meanwhile, the World Gold Council (WGC) reported safe-haven buying in exchange-traded funds and physical gold in North America and Europe.

The council's database of physically-backed gold exchange-traded funds showed continued inflow last Wednesday and month-to-date inflows totalling 18.8 tonnes, with all regions in positive territory, said John Reade, chief market strategist at WGC.

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“We’ve also heard of a pick-up in bar and coin demand from Europe and North America and seen a slowdown of purchases in important jewellery markets due to the jump in price, which again indicates that safety and certainty are the order of the day,” he said.

Meanwhile, Goldman Sachs forecasts gold to reach $2,050 a troy ounce over the next year due to concerns about financial stability and growth.

In the presence of elevated fear and recession risks, gold’s downside in the case of a soft landing or further Fed hawkishness is significantly less than gold’s upside in the case of a growth shock that pushes the economy into a recession, the bank said.

“With growth worries likely to remain above normal, we would expect gold to be tightly linked to real rates if they continue to fall, but relatively weakly linked if real rates increase alongside growth worries and market volatility.”

Updated: March 30, 2023, 3:41 AM