Why is Goldman Sachs expecting a gold rally?
Now is the time to buy gold, according to Goldman Sachs’ latest commodities research report, Gold: Time to buy the defensive real asset. The report analyzes the current economic environment and looks ahead to estimate the price of gold.
Below is a summary of Goldman Sachs’ reasons to acquire gold.
Weaker US growth and high inflation will spark gold demand
Goldman’s economists are forecasting “a material deceleration in US growth.” Weak economic growth combined with high inflation and expected rate hikes create a “risk-off” environment, in which investors want to shy away from risk assets like stocks, the bank says. In a risk-off environment, people tend to gravitate towards lower-risk assets such as gold.
In December, Goldman Sachs lowered its 2022 forecast for GDP growth to 3.8% from 4.2%, and in January it decreased it further to 3.2%. The International Monetary fund is a little more optimistic in its latest World Economic Outlook, forecasting 2022 growth at 4%, but then sees it drop to just 2.6% in 2023. Either way, a significant drop from the annualized rate of 6.9% in the fourth quarter of 2021.
According to a Fed survey of professional forecasters cited by Goldman Sachs, the perceived probability of a recession is starting to increase, and it could rise higher if US growth slows due to the fading fiscal stimulus and the Fed’s tighter policy, “[setting] gold up for greater investor interest.”
The chart below shows GDP growth rate (the blue line) and the perceived recession probability as forecast by Goldman Sachs (the dotted line). Goldman Sachs expects a slowdown in GDP growth will lead to higher concerns about a recession. This will likely increase the demand for defensive assets like gold.
Gold rallies during rate hikes
Goldman addresses the effect of potential rate hikes on gold by stating: “Contrary to many investors’ expectations, gold has remained very resilient during the recent increase in US real rates.” The investment bank argues this is because gold is viewed as both an inflation hedge and a defensive asset.
The bank’s research shows that gold tends to increase during rate hike periods, especially when US economic growth starts to slow down or when higher rates threaten economic activity, which raises the probability of a recession and the demand for defensive assets like gold.
That’s the environment Goldman forecasts we’ll likely face soon: GDP growth is expected to slow, while the Fed is expected to raise interest rates up to seven times this year.
The chart below shows the performance of gold in the months following the first rate hike. On average, the price of gold increased around 30% over the 24 months following the first rate hike.
Gold is a hedge against structural inflation
In 2021, inflation was perceived as transitory both by the markets and by the Fed. This was also the case in the early 1970s where gold’s performance was muted and only rallied “after central bankers’ credibility was lost and [inflation] expectations began to rise in the second half of the decade.”
According to Goldman, the “de-anchoring” of inflation (the point when inflation expectations start to rise) in the 1970s happened after the 1973 oil price shock. And that’s when the price of gold started to take off because the volatility created by unanchored high inflation motivates people to look for ways to preserve their wealth.
Goldman Sachs says we could see a significant increase in the price of gold “if inflation expectations would de-anchor and the Fed would stay[s] behind the curve making markets doubt its commitment to bringing inflation down.” In a scenario where inflation increases significantly, the investment bank sees significant upside potential for gold.
Gold is a geopolitical hedge
How well does gold perform as a geopolitical hedge? Goldman Sachs’ research shows that the precious metal does particularly well following geopolitical events with direct US involvement (such as 9/11 and the 2003 Gulf War). In contrast, gold practically didn’t respond to Russia’s annexation of Crimea, but is rising now fast and furious with the war in Ukraine. Is it because the US is perceived to be involved in this war with the US sanctions placed on Russia?
At the time of writing this (February 24), Putin has just begun the invasion of Ukraine. The response from world leaders have been swift, and The White House is expected to unveil the most punishing sanctions ever imposed on Russia.
What is Goldman Sachs’ forecast for the price of gold?
Based on the factors outlined in its report, the investment bank has updated its outlook for the price of gold to $2,150/oz in 12 months from their previous forecast of $2,000.
That’s the low end of its prediction. If inflation expectations de-anchor and the Fed stays behind the curve, markets could start losing confidence in the central bank to bring inflation down, and high inflation could become structural. In that scenario, Goldman Sachs predicts the price of gold could go all the way to $2,500. That’s an increase of almost 30% compared to today (February 24).