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Gold is a 'rational market,' but industrial metals are the winners - Liberum analyst

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(Kitco News) The gold market has been rational for the past three years, making it easier for investors to analyze it, according to investment bank Liberum.

Gold went through significant turbulence in the past three years, trading below $1,500 an ounce and rising to new record highs above $2,050 an ounce.

But despite the volatility, gold's price direction has been relatively easy to explain, Liberum analyst Tom Price told Kitco News.

"After the lockdown of 2020, what gold and other commodities were responding to was capital being pumped into economies. It was an offset for weak growth. We started to see an inflation problem emerging. Part of the reason for that was economies competing with each other to restock all commodities at the same time," Price said.

It was a very aggressive and simultaneous push by countries into industrial commodities. "And gold got swept up in that because people who invested in gold recognized the inflation shock that was coming," Price explained.

But once the market realized that the Fed was getting serious about its rate hike cycle coming into 2022, all commodity markets settled down. "It flushed out the speculators from the commodity space because they could get returns on other assets. Gold came off 15% from the Ukraine-war high of March."

And it was only the slowing of the Fed's rate hike cycle in the fourth quarter that pushed speculators back into the gold market. "With the rate hike cycle slowing, bullish factors started to emerge — China's lockdown was easing, and Russia's war was still going. So that anxiety trade was there."

At the start of this year, gold's primary drivers were these two bullish factors. At the same time, the Fed moved into the background. "So those two bull factors overwhelmed that bear factor. And that's what drove the gold price up into the new year," Price elaborated.

However, this did not last, with the Fed returning as the dominant gold price driver. This view solidified after Fed Chair Jerome Powell warned of the possibility of higher and quicker rate hikes due to robust economic data and uncomfortably high inflation. "Now everyone is coming to terms with the fact that the U.S. economy is doing very well and the Fed's going after inflation," Price described. "To me, that all makes sense."

With gold responding so well to these three drivers, analyzing the market becomes easier, Price pointed out. "I can actually rationalize gold's price performance in terms of the three dominant drivers of the price — the Fed, China, and the Ukraine war. And I can see the price performances reflecting the dominant drivers through the last 12 months. And it's pretty rare to actually say that about any commodity market. Gold is a rational market at the moment," he said.

The Fed question

With markets gearing up for the March Fed meeting in less than two weeks, investors are already pricing in a 77% chance of a 50-basis-point hike, according to the CME FedWatch Tool.

But there is one unknown to keep a close eye on — what Powell says versus how markets react, Price told Kitco News.

"I'm fascinated by the fact that Powell says one thing — 'we're officially hawkish' — but markets are coming up with their own interpretation," Price said. "There's a real conflict between the Fed's and the markets' views."

This means there is a massive amount of capital on the sidelines waiting to come back into the market, according to Price. "It's been steadily withdrawn during 2022. And now people want to get back in and make a profit in these markets. But the Fed's not letting them, not for a while, anyway," he said.

With the Fed remaining more aggressive than expected, a no-yield asset like gold will struggle. "That's the sort of pressure that gold is under at the moment and explains the sell-off in the last few weeks," Price said.

Liberum is projecting for the U.S. economy to start slowing in the second quarter but avoiding a recession this year.

The gold outlook that Price described is bearish due to the Fed keeping rates elevated for longer and the U.S. economy seeing lackluster growth.

Liberum has an average gold price for this year of $1,690. The quarterly averages are $1,795 for Q1, $1,710 for Q2, $1,630 for Q3, and $1,630 fro Q4. In 2024, the bank sees gold stabilizing above $1,600 an ounce.

"I'm expecting the Fed to keep rates substantially positive over the next 12 to 24 months and a positive growth outlook for the economy. People will start moving their investments into other commodities, especially industrial metals," Price said. "I'm strictly a bear on gold over the next two-three years."

Silver and industrial metals to outperform gold

In light of this outlook, Liberum is looking for industrial metals, including silver, to outperform gold. One reason for that is U.S. President Joe Biden's materials-intensive infrastructure program.

"We're more constructive on industrial metals versus gold. The U.S. is starting to deploy its materials-intensive infrastructure program. The Biden-approved program, which he put to Congress in 2020 and got approved in 2021, is now getting to the stage where they have to start pulling together raw materials. It is road-rail, communications, and EVs," Price said. "It's worth $570 billion, and it is part of a package of over a trillion. It will probably be deployed over the next three to five years."

A program of that size will require the U.S. to import commodities due to insufficient production capability or lack of surplus. "I would encourage investors who probably got some money in gold to swing some of it over into commodities like copper, aluminum, nickel, and zinc," Price added. "Copper is the communications and the EV story. Zinc is for galvanizing and steel. Aluminum is a substitute for steel and copper. And nickel is used for stainless steel production."

And for silver, 50-55% of its demand is industrial-related, which makes it a winning combination for the metal. "I can definitely see a case of silver outperforming gold if our constructive view on the U.S. economy plays out," Price said.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.