An Asymmetric Payoff": Why Goldman Sees Gold Soaring 30% When The Fed Starts Cutting Rates

11.9.22 - I'm Selling My Blood To Eat, I Have No Choice

Gold last traded at $1,706 an ounce. Silver at $21.12 an ounce.

" - Zero Hedge--At a time when it seems there is a drought of good news, we may finally have some for gold investors from Goldman. These remarks are reflective of what has been a pretty consistent and long-standing tradition of the yellow metal being a safe haven - or hedge - during inflationary periods.

In recent weeks, gold has been caught in a perfect vice of bullish and bearish forces.

On one hand, the Hawkish Fed has continued to pile relentless pressure on the precious metal; to wit, during his recent press conference, Chairman Powell hinted at slowing down the pace of rate hikes, while also signaling that terminal rates may peak at a higher level. Following the conference, US rates and the dollar surged. Importantly, the Fed reiterated that bringing inflation down to 2% remains a top priority, triggering a sharp fall in gold after the announcement.

But wait, isn't inflation good for the world's oldest inflation hedge? Well, as Goldman's Mikhail Sprogis writes in a note this morning, in given circumstances, it is: for example, high inflation tends to be (extremely) bullish for gold when the market questions the central bank's ability to fight it, such as during Burns's tenure in the 1970s. In contrast, high inflation tends to be bearish for gold when the market gives the CB credit in its ability to reduce it, such as during Volcker's fight on inflation in the early 1980s.

In any case, the Fed's consistent message that it is willing to sacrifice growth to bring inflation under control has helped keep breakeven inflation expectations stable and pushed real rates to the highest level since the GFC. As a result, gold ETFs and speculative positions have fallen as the effect of higher real rates has offset the impact of rising recession worries.

On the other hand, as we reported last week, Central Bank buying of gold, especially among emerging markets, just hit a record: according to the World Gold Council, in Q3 2022 CB gold purchases of 400 tonnes, the largest quarterly figure on record, and 300 tonnes above trend.

As an aside, and as we discussed last week, the record-high buying emanated from an "unexplained" component of the World Gold Council data, which reflects purchases by countries which either do not report their activity or report with a lag. For example, Russia stopped reporting gold purchases this year, while China often reports with a large lag. The largest reported purchases came form Turkey, Uzbekistan and Qatar. Still, one thing we can be reasonably sure of is that the buying is done by a combination of EM CBs. Meanwhile, DM CBs have not been significant gold buyers since the 1960s.