Why Stagflation Could Polarize Gold And Silver

As the Federal Reserve maintains a dovish tone, bond yields have risen and the dollar remains strong. As a result, while forecasts on gold have lowered, the risk that central banks may have overdone it could send its value soaring —especially if inflation remains elevated while economic growth continues to hurt.

Silver should remain fairly in sync with gold in a base case where inflation moderates without a recession. However, a contraction in the industrial sector could hit it disproportionately.

Revisiting Gold Estimates

According to the report “Q1 2023 Gold Outlook: Is Gold Coming Back from the Alternate Universe?” by WisdomTree, outlooks have shifted acknowledging the sell-off in bonds and the stronger dollar. 

The consensus has also revised inflation estimates upwards, recognizing the tenacity of prices despite the restrictive measures of the central banks. Higher bond yields and a stronger dollar are weighing on gold prices negatively, while higher levels of inflation are weighing in positively.

The report indicates that, going into the first quarter of 2023, gold prices will rise but not as much as previously expected —around $2,300/oz— when bond and dollar headwinds were lower.

“We assume, in our revised projections, that 10-year bond yields will rise to 3.2% (currently 2.80%) and the dollar basket appreciates to 105 (currently 102) by the first quarter of 2023, while inflation only moderates to 4.3% (from 8.3% in April 2022) —the bearish and bullish scenarios are not altered by these changes.

Gold continues to defy bond hurdles

Gold is holding up well relative to bond markets, breaking its traditional strong relationship with inflation-protective Treasuries.

The precious metal is generally an asset that performs well in adverse economic and financial conditions. So, faced with growing fears of a recession, investors are turning to gold as a hedging instrument.

Year-to-date inflows in ounces have amounted to 7.3 million in gold-traded commodities (ETCs) as of May 24, 2022, compared to net outflows of 9.2 million for all of 2021.

Stagflation could be good for gold

Traditionally, recessions tend to temper price pressures. However, when price increases are generated by external shocks, this may not happen —and market pundits are increasingly talking about stagflation.

Stagflation episodes are extremely rare and therefore it is very difficult to draw quantitative conclusions from them. Between the third quarter of 1973 and the first quarter of 1975, US GDP fell in real terms, and, furthermore, inflation rose from 7.4% to 10.3%.

For its part, gold prices increased by 73% in that period. The late 1970s also saw an economic slowdown combined with accelerating inflation, with gold prices more than doubling in 1979.

A recession could treat silver differently than gold

Based on a revised base case gold estimate, WisdomTree’s silver model indicates that silver prices are likely to rise to $28.89 by the first quarter of 2023 (from $21.93/oz ).

Mining Capex has been on the rise recently and this could push the silver market into a supply deficit over the next year as manufacturing activity —proxied by the Purchasing Managers' Indices— will continue to moderate, but will not drop below 50

“Our projection for silver indicates that the gold/silver ratio, which is currently elevated, could moderate somewhat.”

According to the report, if a recession becomes the main driver of gold prices, manufacturing activity could contract, putting negative pressure on silver prices as gold continues to appreciate. This could increase the gold/silver ratio.

In conclusion, while the outlook for gold and silver is hampered by higher bond yields and dollar appreciation, stubbornly high inflation should push their prices higher.

“We emphasize that while a recession is not our base case, markets are increasingly concerned that the economy will decline. Gold returns could outperform silver in such a scenario.”