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Gold is a 2023 story, but these are the currencies to buy it in right now

Kitco News

(Kitco News) Gold is down 8% year-to-date, and there might not be enough momentum to reverse course this year. But that's only the case for gold priced in U.S. dollars, according to Pepperstone's head of research Chris Weston. Here are the currencies that should be on your radar.

There's been a big debate about gold as an inflation hedge, especially after it pulled back from the $2,000 an ounce level posted in March. But the disappointing price action does not mean that gold failed, Weston told Kitco News. It is all about inflation expectations for gold, which have been low, while the CPI numbers have been at 40-year highs.

"Gold is a hedge against expected inflation rather than realized inflation," Weston said Tuesday. "Gold's held up pretty well relative to real rates. People are looking at the wrong type of inflation. It's more about inflation expectations and breakeven rates. If you look at five-year breakeven rates, they reached a high of around 3.76% in March and then came back to 2.43%."

Using this correlation between gold and breakeven rates, Weston sees gold's fair value below $1,600 an ounce. At the time of writing, December Comex gold futures were trading at $1,679.70, down 0.37% on the day.

Not much is likely to change until next year when it comes to gold priced in USD, with Weston waiting for a peak in the U.S. dollar to usher in higher gold prices.

"Gold is a 2023 story. I do see signs that the dollar will be an under-performer in 2023," Weston said. "Next year, we'll see a weaker dollar that may set the stage for real rates to have a bit of a turn. That's where we'd be looking at gold quite favorably."

The first thing to watch next year is the Fed's terminal rate. At the September meeting, the Fed officials said they see the federal funds rate climbing to 4.6% next year after rising to 4.4% by the end of 2022.

The U.S. central bank raised rates by 300 basis points this year, taking the current range between 3% and 3.25%.

"In theory, we'd like to see that terminal rate coming down. If you look at the full year for next year, we've got about 24 basis points of cuts," Weston noted. "Yet, the Fed has made it pretty clear that they will not cut rates next year."

The idea that we could see rate cuts next year would force the greenback lower and gold higher.

"If the market bought into the idea that we were getting a disinflationary shock and we were to price in a larger element of rate cuts into the second half of next year, that would be the trigger for a very extended dollar market to start reducing some of those positions. We could see a risk-on rally in equities into the year-end, and gold would follow that trend."

What's the best currency to buy gold in?

Around 90% of people trade gold in U.S. dollars, but if investors want to become more niche, then they need to look into buying gold in the weakest currency and shorting it in the strongest currency, according to Weston.

That is one of the reasons why gold has been underperforming in U.S. dollars relative to some of the other currencies. "If you get this right, you can max out the currency effect on the back of this," Weston said.

Gold in the Australian dollar is up 6.6% in the last 30 days and up 1.24% in the last six months. Gold priced in British pounds is up 2.3% in the last 30 days and is flat over the previous six months. In comparison, in the U.S. dollar terms, gold is down nearly 3% over the last 30 days and down 15% in the last six months.

"That's the currency effect there," Weston described. "Gold in Aussie dollar terms has worked incredibly well since September 16. We've seen that trading from around $2,500 up to $2,657. We've got most of the April highs and the March highs kicking in just below $2,700. Gold in pounds had a nice move since July and has been grinding higher. We're just pushing £1,531 at the moment, and that needs to break to keep the momentum going."

The equity risk remains elevated, which puts these currencies at risk of further downside. "We still see the Aussie dollar at risk to get into 60 cents. The pound also faces greater downside risks after the Bank of England rolls off its temporary monetary support mechanism," he added.

Meanwhile, the U.S. dollar remains an overloved currency, which gives an opportunity to short gold.

"If I wanted to trade gold to the upside, then I would look at what we perceive to be the weakest currencies, and that continues to be the Aussie, the Kiwi, and the pound," Weston pointed out.

Weston is not so sure about gold in the Japanese yen even though it has been this year's focus as the yen has acted as a bond proxy.

"The yen has been the big underperformer. But we're on intervention watch, which just keeps me a little bit cognizant of trading gold in the Japanese yen. If we were to see the Bank of Japan making noise about intervening again, then gold in Japanese yen terms would probably work quite well as well," he noted.

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