According to commentary released by the World Gold Council (WGC) on April 6, the gold price rose by 9.2% during the first quarter to $1 980/oz, propelled by fears of an economic crisis and simmering geopolitical tensions, while the sudden banking mini crisis triggered by the collapse of Silicon Valley Bank (SVB) drove gold higher towards the end of the quarter, with yields and the dollar remaining ever-present drivers.
The WGC said that, towards the end of the quarter, gold was unsuccessful in sustaining momentum above the $2 000/oz level, which it hit on three separate occasions in March. As concerns over the banking crisis eased, gold fell back somewhat as tactical demand for safe havens abated.
On a quarterly average basis, gold jumped to $1 890/oz, just 1% off the record high seen in the third quarter of 2020 at $1 911/oz. This was against a backdrop of increasing confidence that the cycle of monetary tightening may soon end, the WGC said.
Using the WGC’s Gold Returns Attribution Model (Gram), gold found support from lower yields and, to a lesser extent, a weaker dollar. It was a tumultuous quarter for yields, with a spike in interest rate volatility as rate expectations were repriced in response to the SVB event, the WGC said.
Meanwhile, yields on US ten-year treasuries fell by 40 basis points, thereby boosting gold’s performance.
“We believe that focus should also be placed on the unexplained component of the model which was positive in each of the first three months. This could, in part, represent the continued strength in central bank demand for gold,” the WGC said.
Using the rule of thumb from the WGC’s Qaurum model – an interactive tool that is meant to make the understanding of gold performance easier and more intuitive – that it takes about 30 t of gold demand to move the price 1%, a 4.8% cumulative residual suggests a figure of about 140 t gold, which coincidentally is close to that already reported by central banks so far.
By contrast, global gold exchange-traded funds (ETFs) have had a much tougher start to the year, the WGC said. Echoing this was net positioning in COMEX gold futures, which remained relatively subdued for much of the quarter. However, March saw combined inflows that have been previously unmatched since June 2019.
The WGC said that gold closed 2022 in resilient fashion, buttressed by central banks and retail investors as rates and the dollar soared. The first two months of 2023 started in a similar vein.
“But gold’s mere resilience has been a disappointment to some. The last 12 months of heightened geopolitical tension and a 40-year high in inflation should have been an environment in which gold could thrive, and a flat year left many asking whether gold should not have done better,” the WGC said.
However, if this had been the case, the impact on other corners of the markets would have likely been far worse, the WGC mused.
“Although bonds had one of their most dire years for decades, it was barely a bear market for equities, while 2022 experienced neither recessions, defaults, bankruptcies or large-scale layoffs. Also, unless one was unfortunate enough to have bought at the beginning of 2022, the drop in equities would have been cushioned by stellar prior returns but during March provided the first cracks in the US economic armour, which appeared with several small bank failures,” the WGC said.
It said it was, therefore, not surprising that, after such an unprecedented pace of hiking, something had to give, and that the problem with banks was that they were inherently part of a fragile system.
“Fractional banking works well until it doesn’t,” the WGC said.
For now, the focus is on small banks and the sector they are intrinsically wedded to commercial real estate (CRE). As yet, the outcome of this mini crisis episode remains unknown.
Currently the US Federal Reserve (Fed) and other central banks’ initiatives have prevented an escalation of deposit-flight woes at banks and a full blown CRE doom-loop crisis also looks contained, according to the WGC.
The most visible distress, it said, is evidenced by the oversupply of office space, largely a consequence of remote working. This is a relatively small part of the CRE sector and represents about 4% to 5% of debt that needs to be refinanced in 2023.
“Valuations across the CRE sector are lofty, but lofty valuations, unlike defaults, are not in themselves a systemic issue. The CRE sector remains cushioned for now with loan to value ratios at manageable levels,” the WGC said.
It further explained that markets were not positioned for a tail event and that, despite the increasing proliferation of tail events over the past two decades, there had been a lull in the last 12 months.
The WGC said, however, that market complacency about such risks was a worry.
“A bit of complacency, faith in central bankers and equity market resilience makes for an uneasy cocktail in the event of a full-blown crisis. But since such crises are almost impossible to time, a strategic holding to gold makes sense,” the WGC said.
Gold has historically responded well in such scenarios, as it did recently during the Ukraine invasion in February last year and the Silicon Valley Bank collapse in March, a pattern that is historically proven for gold during such times of volatility.