Gold gives way to dollar strength


Gold succumbed to the pressures of rising yields and a strong US dollar in September, but is positioned to benefit when market dislocation reverses.

Gold gives way to dollar strength

Gold fell below US$1,900 per ounce in the final week of September. Gold tested the US$1,900 level at the end of June, and again in August, but found support and bounced above it. However, this time, it failed to find support, dropping to US$1,849 per ounce on September 29, a US$92 loss (-4.7%) for the month. Most of gold’s gains for 2023 have been given up. After resilient performance in the first half of the year, gold succumbed to the pressure of rising yields and a strong US dollar in the third quarter of the year.

US 10-year and 30-year treasury yields are just shy of 5% at present and the US dollar (as measured by the US Dollar Index, or DXY) managed to climb a whopping 6.4% from its mid-July lows to the end of September. The historically strong, inverse correlation between gold and the US dollar was on full display, with gold dropping 5.7% during the same period. What was expected to be a US Federal Reserve (Fed) pause at its September 20 meeting, instead turned into a skip and hold. The Fed chairman made it clear to markets that they were prepared to hike again if needed and hold policy rates at a restrictive level to continue their fight against inflation. Gold and gold equities sold off along with the rest of the US equity markets and bonds. The NYSE Arca Gold Miners Index fell 7.81% during the month.

Demand from the East lends support to the West

The gold price in China also dropped, reducing a record US$120 per ounce premium over the international spot price to around US$10. Demand out of China has been strong in 2023, with Bloomberg reporting a year-on-year increase of 30% in the domestic sales of gold bars and coins as of last week. This pickup in demand from China, as well as from Turkey—together, representing two of the largest gold consumers in the East—has helped to fill the gap left by declining western investment demand, as reflected by persistent outflows from gold-bullion-backed ETFs. Strong central bank gold buying has also supported gold prices.

Investors in China and Turkey are using gold to hedge against economic risks and weakening currencies. Turkey has been experiencing hyperinflation due to unconventional monetary policies. Since the presidential elections in May, the government has taken steps to restore confidence. However, there remains a high level of uncertainty. In China, the slowing economy, along with fallout from its real estate bust and government crackdown on the tech sector, has also created financial uncertainty. Central banks are buying gold to diversify away from the US dollar and as a hedge against market volatility. Its performance during times of crisis, its role as a long-term store of value, and its high liquidity make it an asset of choice.

Well-positioned vs. “consensus” with gold?

In contrast, Western investors have yet to find a reason to seek shelter in what has been a robust year for equity markets, particularly tech stocks. A “soft landing” appears a possibility, and with inflation decreasing, markets seem to think there is no reason to invest in gold for its hedging properties. However, equity valuations are rich, and the prospect of sustained, elevated interest rates poses a significant risk to most sectors and the entire economic and financial system. British pension funds, Credit Suisse, Silicon Valley Bank and Signature Bank were all victims of rising rates. 

The weakness in gold markets in recent weeks comes at a time when these risks are at the forefront. This creates a notable market dislocation. Should any of the following scenarios happen—i.e., if markets are hit with a drop in corporate earnings, a deep correction in equity markets, a weaker jobs market or higher unemployment, along with sustained, high interest rates under the stress of above-target inflation—we think gold is well positioned to benefit. In our view, gold equities should benefit to an even greater extent. Gold equities are currently trading at historically low valuation multiples, and lagging gold bullion. The gold mining sector’s balance sheets, cash flow generation and capital allocation strategies are as strong as they have ever been.

Stepping out: gold conference recap

Last month, we attended two of the sector’s major conferences, both in Colorado: Precious Metals Summit, in Beaver Creek, focused on explorers, developers and emerging producers; and Gold Forum Americas, in Colorado Springs, which showcases seven-eighths of the world’s publicly traded gold and silver companies when measured by production or reserves. We held meetings with the management teams of more than 50 companies during the two conferences.

The mood at Gold Forum Americas was quiet and reflective, not surprising given the recent lack of investor appetite for gold equities and the resulting poor share price performance of many of the companies. However, the message continues to be upbeat, with a focus on portfolio optimisation, disciplined growth, cost control and delivering against expectations. The companies understand that to achieve a re-rating and attract a broad investor base, they need to demonstrate to the markets that this sector is investable throughout the metal price cycles. They require a strategy that focuses on value creation by reducing costs, increasing mine lives as well as finding and developing new deposits, all while maximising returns for stakeholders.

At the Precious Metals Summit, one CEO commented that this market felt like the bottom of the bear market in 2015 when gold fell to US$1,050. However, the gold price is now in a bull market trend, with gold recently near record highs, and internal rates of return on many projects ranging between 20% and 50% or more.

Published: 12 October 2023

Any views expressed are opinions of the author at the time of writing and is not a recommendation to act.

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