What factors influence the price of gold? For much of the previous decade, the answer was simple: the cost of money. The lower interest rates fell, the higher gold rose, and vice versa.
Because gold is the classic “anti-dollar” — a safe haven for those who detest fiat currency — it seemed reasonable that prices would climb in an environment of low real interest rates and cheap dollars. When interest rates rose, gold, which offers no yield, became less appealing, sending prices plunging.
Bullion has barely blinked as inflation-adjusted rates reached their highest level since the financial crisis this year. Real yields on 10-year Treasury inflation-protected securities, or TIPS, rose further on Thursday to the highest since 2009, but spot gold fell 0.5% on the same day. When actual rates were this high, gold was roughly half the price.
The unraveling of the link between gold and real interest rates may represent a paradigm shift for the precious metal, leaving investors scrambling to compute its “fair value” in a world where the traditional formulae no longer appear to apply. It’s also prompting doubts about when and when the old dynamic will resurface – or whether it already has, albeit from a different starting point.
Analysts attribute the rally to a combination of ravenous central bank buying, headed by China, and investors who believe a US economic downturn will benefit gold, even when conventional wisdom says it’s time to sell.
“Our models told us it’s $200 too expensive,” said Marco Hochst, a Berenberg portfolio manager. Nonetheless, the firm’s 319 million-euro ($340 million) multi asset balanced fund, which he helps manage, retains approximately 7% of its assets in gold. “Gold appears to have a much brighter future in our opinion.”
Many analysts develop their own models or computations to estimate the fair value of gold, but most of them follow the basic concepts of where bullion is trading in relation to real US bond yields and the currency. Normally, money managers would sell the safe-haven metal when the dollar strengthens and the yield on other secure assets such as bonds and cash rises.
However, they have not done so on the expected scale, resulting in a significant “premium” to where the models predict it should be trading.
“I get no return on gold, but I can get a return on cash.” “Where am I going?” asked Ameriprise Financial Inc.’s top market strategist, Anthony Saglimbene. “I’m surprised at how resilient gold has been in that regard.”
The “premium” has lasted for nearly a year, thanks to a record gold-buying splurge by central banks, which has helped the metal weather global monetary policy tightening.
There are some early indications that sovereign demand is slowing, making gold more vulnerable to downturns. The decision of institutional investors to sell if prices fall to new lows will be critical to the outlook.
Some analysts suggest, however, that rather than collapsing completely, gold’s relationship with its primary drivers has just been reset at a higher base.
According to Macquarie’s Marcus Garvey, who sees prices climbing to $2,100 per ounce next year as the US economy weakens, this might allow it to hit a record if rates or the dollar fall again.
“There has been a level break higher in the nominal gold price,” stated Garvey. “Once you get the financial flows as a tailwind, I think it makes for a decent push higher.”
The turbulence that rocked the US banking sector in March may have served as a litmus test. As Silicon Valley Bank teetered on the verge of failure, real rates and the dollar plummeted, spurring fresh inflows into gold-backed exchange traded funds.
Despite already trading at a premium, the metal rose to within striking distance of the epidemic high, but subsequently fell as the situation subsided and investors sold into the higher prices.
Others, though, are dubious of a repeat, especially now that the prospect of a banking crisis has receded and bonds are offering real yields for the first time in years. With gold appearing to be somewhat expensive, it may struggle to draw major flows even in the event of a US downturn.
Please note that this article does not offer any instructions or suggestions regarding investment decisions. It is important for you to conduct your own research or seek professional advice from a qualified professional before conducting an investment decision.