Gold can shine even brighter

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Markets have breathed a temporary sigh of relief as US tariffs against Canada and Mexico have been put on hold for now, and China’s initial retaliatory response has been considered restrained. As of the close of trading on Wednesday, the S&P 500 has edged up 0.4% so far this week, while futures point to a positive open for Thursday. The rally in gold prices, however, suggests investors remain on edge.

Gold has made fresh all-time highs this week amid tariff concerns and more evidence of heavy central bank buying, trading above our long-held forecast of USD 2,850/oz. This marks a climb of more than 10% since mid-December, when the Federal Reserve signaled a more hawkish stance around its pace of monetary policy easing. While we acknowledge the current spot price of USD 2,870/oz is above our fair-value estimate, gold’s enduring appeal as a store of value and hedge against uncertainty has again proven itself. We have therefore raised our gold forecasts to USD 3,000/oz over the next 12 months.

Our base case remains that significant tariffs against Canada and Mexico are unlikely to be sustained for a prolonged period, and that the ratcheting up of the US’s effective tariff rate on China to 30% will be gradual. But, we also believe gold will continue to be supported throughout the year by elevated uncertainty, an extension of the global rate-cutting cycle, and strong investor and central bank demand.

Geopolitical uncertainty lingers, underpinning gold’s appeal. In addition to tariff concerns that are likely to remain an overhang in the months to come as the US looks to address persistent trade deficits and “unfair” trade practices, there appears to be no immediate resolution in sight to the Russia-Ukraine war, and geopolitical tensions in the Middle East remain elevated. US President Donald Trump on Tuesday issued a new memo “aimed at driving Iran’s oil exports to zero,” and separately said the US could take over control of the Gaza Strip, “…develop it, create thousands and thousands of jobs, and it'll be something that the entire Middle East can be very proud of.” While the temporary ceasefire between Israel and Hamas is a promising development, a more sustainable agreement will be harder to negotiate.

Fed cuts still on track. The US central bank kept rates unchanged last week for the first time since beginning its easing cycle in September, citing still elevated inflation and solid labor market conditions. But we believe the Fed will resume cutting rates later in the year, with inflation likely moderating toward the central bank’s 2% target by mid-year. Fed Chair Jerome Powell also said the current monetary policy is still “meaningfully” above the neutral rate, giving scope for further cuts. Lower rates should reduce the opportunity cost of holding non-interest-bearing assets, supporting the investment case for gold.

Strong central bank demand should continue to support gold. The latest data from the World Gold Council released on 5 February showed that overall gold demand in the fourth quarter of 2024 reached 1,277 metric tons, up almost 12% from the same period in 2023. More specifically, strong central bank buying during the three-month period brought their full-year purchases to 1,045 metric tons, on par with levels seen in the previous two years and double the average of around 500mt between 2011 and 2021. We think diversification and de-dollarization trends should lead to continued solid central bank demand in the coming years. Moreover, an increasing US federal deficit and the worsening of its debt profile over the long run should also underpin gold’s attractiveness versus the US dollar.

So, we continue to see gold as an effective portfolio hedge and diversifier, and believe an allocation of around 5% within a USD balanced portfolio is optimal. Direct exposure to the metal may dampen risk in portfolios. Structured strategies linked to gold may be able to sell volatility to generate yield while potentially offering the opportunity to buy gold at prices lower than current levels. Equities linked to gold (such as gold miners) may offer greater capital gains potential but are likely to be more volatile and act like equities in times of risk aversion. We believe gold and the means to invest in it (directly or indirectly) should form part of a well-diversified portfolio.