Investment Strategy

Gold may need a breather

Gold prices climbed to new highs of $2,951 per troy ounce on February 24, marking the 10th time gold prices have achieved a record high in 2025. We’ve been pointing out for the past year that the rally has largely been driven by persistent purchases from central banks, which now account for 21% of global demand, up from 11% in 2021.

In fact, 2024 marked the third consecutive year in which central banks purchased over 1,000 tons of gold. To put that in perspective, over the decade prior to the buying spree, which began in 2022, central bank purchases averaged 511 tons annually, or roughly half of the purchases seen today. Within this trend, emerging market central banks have been especially keen to gold.

While central banks have received much of the attention, heightened geopolitical risks have also come into play. Numerous tariff announcement by the current presidential administration this year have stoked fears of potential trade wars and geopolitical tensions. We believe speculation around the outcome of these risks is pushing more investors toward perceived safe-haven assets, driving gold prices even higher. This relationship can be seen in Chart 1, which uses the number of news stories mentioning trade, tariffs, and wars as a proxy for sentiment and concerns around trade risks. Notably, the spike in these concerns has coincided with gold’s recent move higher.

Chart 1. Gold prices have rallied on growing trade risksSources: Bloomberg and Wells Fargo Investment Institute. Weekly data is from Feb. 23, 2024, through Feb. 14, 2025. Past performance is no guarantee of future results.

Looking ahead, we expect central bank demand to continue to be a tailwind for gold’s outperformance. China’s central bank, one of the largest purchasers of gold in recent years, continued to expand its gold reserves in January, an early indication that central bank buying could persist. However, we suspect that speculation on trade risks and overly positive sentiment could lead to a near-term pullback before we see another sustainable leg higher.

Another way to see this overly positive sentiment is through data showing weekly commitment of traders’ positions. Chart 2 shows net speculative positions among gold traders — long positions minus short positions — against the price of gold. Notice how gold prices have often pulled back shortly after speculative positions reached a peak. Today, with net speculative positions near recent peaks, we believe that a pullback in prices could be in-store.

Chart 2. Commitment of traders’ net speculative positions versus gold pricesSources: Bloomberg and Wells Fargo Investment Institute. Weekly data is from Jan. 4, 2019, through Feb. 21, 2025. Past performance is no guarantee of future results.

The bottom line is that gold has had a tremendous rally in recent years. However, we suspect that speculation about the outcome of announced tariffs and overly positive sentiment have pushed gold prices to frothy levels. In essence, gold prices could be running ahead of themselves and will likely need a breather.

We are maintaining our favorable outlook on Precious Metals and our year-end price target of $2,800 – $2,900 per troy ounce. We favor patience and believe investors should wait for a pullback in prices before adding exposure. For those looking to put capital to work now, we see opportunities to take profits at current prices and rotate into other sectors that will benefit from what we believe will be an improving macro outlook this year. These include our favorably rated Energy sector and neutrally rated Industrial Metals sector.

2025 bringing more drivers to Industrials

Even as the broader industrial landscape was languishing for much of these past two years, demand for equipment related to data centers was surging. This was a key factor in driving sustained and material outperformance by the Electrical Equipment industry. Now, we would acknowledge that there is no longer only one game in town.

We expect the global industrial economy to be somewhat volatile in the near and medium term as it digests an evolving policy backdrop. But in general, we believe there are now modestly higher odds of stronger nominal growth for more mundane end markets in the coming quarters. When coupled with the significant operating leverage that more cyclically oriented firms possess, we are not surprised to see a degree of reversion in relative performance across the Industrials sector in recent weeks as investors attempt to position for a broader backdrop.

This comes in two ways. First, multiples compress for those companies operating in some of the highest-growth secular verticals as investors become somewhat less willing to pay incrementally higher valuations for these earnings in an environment where earnings are less scarce. Second, valuations expand in cyclical areas to account for the rising probability of revenue-driven positive surprises. Our preference would be to maintain balanced exposure within the sector. We do find some cyclical areas incrementally more attractive — namely Trading Companies & Distributors and Industrial Machinery & Supplies & Components, on which we are favorable. But we also still believe areas such as Electrical Components & Equipment and Commercial & Professional Services (we are favorable on both) deserve significant exposure due to strong long-term growth prospects.

S&P 500 Electrical Equipment industry price performance relative to S&P 500 Industrials sectorSources: FactSet and Wells Fargo Investment Institute. Data as of 02/24/25. Past performance is no guarantee of future results.

Canceled federal leases to have limited impact on munis

While finding savings to pay for a Tax Cuts and Jobs Act extension, the White House (through the Department of Government Efficiency) has directed the General Services Administration (GSA) to reduce federal office space. The GSA has notified federal agencies that it is disposing of unused and underused space at an accelerated pace by canceling various federal leases.

Some municipal bonds are secured solely by federal lease payments, such as the National Aeronautics and Space Administration’s (NASA’s) headquarters in Washington, D.C. or the Social Security Administration’s (SSA’s) office building in Birmingham, Alabama. For bonds with no other supporting features, canceling lease payments could result in default. The risk profile on federal lease bonds will be site-specific based on department usage and overall political pressures.

Bonds secured solely by federal leases are rare and represent a narrow subset of municipal bonds, with Moody’s Ratings (Moody’s) covering only 28 federal lease revenue bonds, of which only 10 are GSA leases. This compares to 7,300 active public finance ratings by Moody’s. Of the 10 GSA federal lease bonds, all are rated Baa1 to Ca. Moody’s has rated the NASA and SSA bonds below investment grade since March 2024.

For all other types of municipal bonds, representing most of the market, we expect the residual impact of the proposed lease cancellations to have a negligible credit impact as the total municipal bond market is broad and comprised of many different types of issuers, revenue streams, and geographic locations.

Merger Arbitrage trends improve, yet risks remain

For most mergers, the acquirer generally offers to pay a premium to the target company’s current stock price. While a majority of the spread (between offering price and current price) converges very quickly after the announcement, a portion of the premium often persists and is dependent on the successful completion of the merger. Most Merger Arbitrage strategies attempt to capture this post-announcement spread. The primary drivers of these strategies include the amount of deal activity, the size of the residual premium, the time it takes to complete the merger, or the risk that it may not be finalized.

Deal activity has rebounded modestly throughout 2024 as quarterly volumes rose from around $938 billion to around $1.2 trillion yet remain well off the elevated levels witnessed in 2021 that exceeded $1.7 trillion (see chart). The average deal premium registered 21% in the fourth quarter of 2024¹, which is roughly in line with the longer-term average. Moreover, as the new administration continues to impact policy, we expect that less regulation and more deregulation will likely reduce the length of time needed to complete new deals. In general, shorter timelines may lead to improved returns for Merger Arbitrage strategies as capital may be redeployed into new opportunities.

While many of these trends are encouraging for Merger Arbitrage investors, we continue to monitor several risks that may limit further improvements in deal activity going forward. Most notably, continued stickier-than-expected inflation levels and higher interest rates may limit further improvements in the coming quarters. While our outlook has grown more constructive, we remain patient for further confirmation that the trends remain intact before upgrading further.

Merger and acquisition volumes and deal count on quarterly basis (2020-2024)Sources: Bloomberg and Wells Fargo Investment Institute. Data as of December 31, 2024.

Alternative investments, such as hedge funds, private equity, private debt and private real estate funds are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

¹ Data source: Bloomberg.

Cash Alternatives and Fixed Income

Equities

Real Assets

Alternative Investments**

Source: Wells Fargo Investment Institute, March 3, 2025.

*Tactical horizon is 6-18 months

**Alternative investments are not appropriate for all investors. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. Please see end of report for important definitions and disclosures.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

Alternative investments, such as hedge funds, private equity/private debt and private real estate funds, are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. They entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds. Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. A fund's offering documents should be carefully reviewed prior to investing.

Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value, may expose investors to the risks associated with the use of short selling, leverage, derivatives and arbitrage methodologies. Short sales involve leverage and theoretically unlimited loss potential since the market price of securities sold short may continuously increase. The use of leverage in a portfolio varies by strategy. Leverage can significantly increase return potential but create greater risk of loss. Derivatives generally have implied leverage which can magnify volatility and may entail other risks such as market, interest rate, credit, counterparty and management risks. Arbitrage strategies expose a fund to the risk that the anticipated arbitrage opportunities will not develop as anticipated, resulting in potentially reduced returns or losses to the fund.

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