Although investment bank UBS Global Wealth Management strategists Wayne Gordon and Dominic Schnider have guided investors to hold gold as a long-term hedge to avoid adding or building up additional exposure, they have acknowledged the downside risks to forecasts for the second half of this year if current gold market dynamics persist.

Gordon and Schnider stated in a May 18 note to investors that gold prices had slipped recently as the potential peak in US inflation left the metal vulnerable to higher real interest rates and a strong dollar.

Additionally, speculative net long positions fell to a three-month low.

Despite the recent drop, the spot premium to the strategists’ equilibrium yield-based fair value widened to about $400/oz.

“Gold prices have slipped in recent weeks, finally falling below the 200-day moving average and the psychological level of $1 800/oz. Most technical indicators suggest gold is in oversold territory, although the price momentum is weak. We see the next few days as pivotal to its performance over the weeks ahead,” Gordon and Schnider said.

In the first quarter of this year, inflation surprises and the war in Ukraine, among other factors, led speculators and exchange-traded funds to add gold exposure, and the metal's correlation to the dollar became less negative.

“What's next is not clear cut, particularly given the extent of global uncertainties,” Gordon and Schnider commented.

Typical headwinds had now emerged, the pair said, such as the recent reversal of investment flows alongside the ten-year US real interest rate, which had shifted decisively into positive territory, with US inflation having potentially peaked in March.

Moreover, Gordon and Schnider said fair value models signalled a material misalignment with fundamentals.

“Overall, in the short term, if gold cannot sustain a recovery above $1 840/oz on a 200-day moving average, then greater downsides could be anticipated. Conversely, upside risks could come from how quickly US inflation abates, and from developments in the Ukraine war and the lockdowns in China,” the pair said.

Gordon and Schnider believed that gold would continue to add insurance and diversification in a portfolio context, but advised managing the downside risks ahead.