Gold's outlook for next year? UBS: With the combination of the Fed's interest rate cuts and a significant drop in real interest rates, the price of gold may reach new highs.

Since October, the spot gold price has risen sharply, approaching the $2,000 per ounce mark, supported by expectations of a rate cut by the Federal Reserve. As we approach the end of 2023, is there still room for gold prices to rise next year?

In the latest annual outlook for precious metals released by UBS analyst Joni Teves, it is pointed out that investors' current holdings of gold are not high. As the global economy continues to recover from the COVID-19 pandemic, they have reduced their positions in gold. However, as the cycle matures and policies shift, their attitude towards gold is expected to change accordingly.

UBS predicts that as the US economy enters a recession, the Federal Reserve cuts interest rates, and the 10-year US Treasury yield declines by 160 basis points from its peak in 2023, gold may reach new highs in 2024 and 2025.

According to UBS's basic forecast, the price of gold is expected to reach $2,000 per ounce by the end of next year, $2,200 in 2024, and then fall back to $2,100 in 2025 but remain at a high level.

UBS also predicts that the Federal Reserve will cut interest rates in the first quarter of 2024. If the rate hike is paused in December, this will further confirm the Federal Reserve's inclination to cut rates about 6 months after the last rate hike.

Looking at the performance of gold after previous rate hike cycles, UBS found that about 3 months after the end of the rate hike cycle, the price of gold tends to fall by 2%, but then rises by 7% in the following 6 months.

Compared to UBS, most analysts are relatively conservative and believe that May 1st is likely to be the turning point of the current rate hike cycle for the Federal Reserve, while the Federal Reserve currently believes that the turning point will occur in the fourth quarter of next year.

Currently, the bond market expects the Federal Reserve to cut interest rates by 92 basis points next year, which is much higher than the Federal Reserve officials' expectation of a 50 basis point rate cut next year.

HSBC believes that the trigger for a rate cut is likely to occur in the third quarter of 2024, while the Morgan Stanley team believes that the Federal Reserve will start cutting interest rates in June 2024, and will cut rates by 25 basis points at every meeting after September 2024 and in the fourth quarter of 2024.

Actual interest rates remain the main driving factor for gold prices

UBS has a slightly different view from investors on the impact of actual interest rates on gold prices. The institution believes that actual interest rates are still the main driving factor for gold prices.

Although the degree of this relationship may change over time, one key aspect remains - it is asymmetric. When interest rates fall, the rebound in gold prices is greater than the pullback when interest rates rise.

Compared to historical levels, the sensitivity of gold to real yields has decreased this year, but this asymmetry still exists, making gold an attractive alternative outside the bond market and preparing for lower future rates.

UBS found that for every 100 basis point drop in the real interest rate of 10-year US Treasury bonds, gold prices rise by 11%, but when the monthly increase is the same, gold only falls by 4.2%.

Therefore, if actual interest rates decline in the coming year, gold is expected to benefit. In addition, UBS found that when actual interest rates are below 1.25% and continue to decline, the increase in gold prices is even greater, reaching 14%.

UBS also expects gold to continue to strengthen in the first half of 2025, as actual interest rates may fall below this threshold. According to the institution's estimates, the real yield on 10-year US Treasury bonds will drop by 160 basis points from its peak in 2023 over the next two years.

Investor sentiment shift driving gold prices higher

Investor positions in gold are at a relatively low level, and the gold allocation established during the COVID-19 pandemic has been completely unwound.

Geopolitical concerns have recently increased investors' interest in gold as a safe haven, but UBS believes that a large part of this is short-term investors covering their short positions, most of which are reflected in the options market.

As the future economy continues to weaken, global investors will become increasingly concerned about the macro environment and the pessimistic scenario of a hard landing in the United States, and the escalation of the situation in the Middle East may make gold allocation more attractive.

Central bank "gold rush" expected to continue, providing support for gold

Central bank gold purchases are likely to remain strong. UBS states that although the exceptionally strong purchasing power of recent years is unlikely to continue, historical data still suggests that the purchase volume will remain relatively high.

While these flows of gold themselves are unlikely to drive prices higher, they will continue to play a crucial role in supporting the market and the overall upward trend in prices.

UBS points out that the elasticity of gold prices to rising real yields in recent years is largely due to the historically significant increase in official gold reserves, which has essentially absorbed the gold sold by investors.