Sometimes the market provides us with an interesting mystery. Right now, the mystery is why gold is holding up so well when interest rates are marching steadily higher.
Gold usually moves in the opposite direction to real interest rates – that is, interest rates after deducting for the bite of inflation. When real rates go up, bullion prices go down.
There are excellent reasons why this relationship has held true in the past. Gold doesn’t pay a dividend or offer any yield, so its appeal tends to shrivel when the real payoff from other assets is rising. Investors flock to the more attractive yields on offer from bonds and stocks and ditch the asset that doesn’t pay them anything.
But not this time. Gold’s price has jumped since Russia invaded Ukraine on Feb. 24. It briefly poked above US$2,000 an ounce and has subsided only slightly since then. Bullion is now trading north of US$1,930 an ounce, despite rising real interest rates and the promise of more increases to come as central banks hike rates to battle inflation.
How can we explain this? Broadly speaking, there are two theories.
Theory No. 1: Investors are being silly.
Theory No. 2: Investors are being clever.
The first possibility should never be ruled out. Maybe investors are so spooked by the invasion of Ukraine and high inflation they are willing to pay up for anything that offers a chance of shelter.
However, if they are seeing gold as a haven, they are brushing past a lot of inconvenient facts. Consider inflation, for instance. Despite what many people think, gold has been an unreliable hedge against inflation except over very long periods. Yes, it performed well during the high-inflation 1970s, but that largely reflected a massive catch-up after Richard Nixon’s decision to take the United States off the gold standard at the start of the decade. During the 1980s and 1990s, gold failed to keep up with rising prices elsewhere in the economy.
Gold usually moves in the opposite direction
to real interest rates
Real interest rates on
10-year U.S. bonds
Gold price,
U.S. dollars/oz.
3.5%
$2,200
2,000
3.0
1,800
2.5
1,600
2.0
1,400
1.5
1,200
1.0
1,000
0.5
800
0.0
600
-0.5
400
-1.0
200
0
-1.5
2004
2006
2008
2010
2012
2014
2016
2018
2020
the globe and mail, Source: federal reserve bank
of st. louis
Gold usually moves in the opposite direction
to real interest rates
Real interest rates on
10-year U.S. bonds
Gold price,
U.S. dollars/oz.
3.5%
$2,200
2,000
3.0
1,800
2.5
1,600
2.0
1,400
1.5
1,200
1.0
1,000
0.5
800
0.0
600
-0.5
400
-1.0
200
0
-1.5
2004
2006
2008
2010
2012
2014
2016
2018
2020
the globe and mail, Source: federal reserve bank
of st. louis
Gold usually moves in the opposite direction to real interest rates
Real interest rates on 10-year U.S. bonds
Gold price in U.S. dollars/oz.
3.5%
$2,200
2,000
3.0
1,800
2.5
1,600
2.0
1,400
1.5
1,200
1.0
1,000
0.5
800
0.0
600
-0.5
400
-1.0
200
0
-1.5
2004
2006
2008
2010
2012
2014
2016
2018
2020
the globe and mail, Source: federal reserve bank of st. louis
In contrast, the relationship between real interest rates and gold has been much more dependable. Right now, that relationship has nothing good to say about the outlook for bullion.
Rising real rates combined with a strong U.S. dollar and other macroeconomic factors suggest gold’s price will eventually settle between US$1,200 and US$1,500 an ounce, according to Royal Bank of Canada analysts. For similar reasons, Credit Suisse researchers recently forecast a gold price of US$1,650 an ounce in 2023 and a long-term price of US$1,450 an ounce.
Granted, such forecasts are as reliable as most market forecasts, which is to say not very. However, they do underline the essential point that long-term gold investors appear to be embracing risk at the moment, not running away from it.
This brings us to Theory No. 2: Maybe gold investors are embracing this risk for intelligent reasons. They might, for instance, want a hedge against the possibility of a global economic meltdown. From Russia’s lunatic invasion of Ukraine to China’s painful pandemic lockdowns to inflation-fighting central bankers, there are plenty of reasons to fret about potential disaster scenarios.
But if gold investors are so anxious, why aren’t other investors? Stock markets have retreated in recent weeks, but are refusing to panic. Despite Friday’s big swoon, they are still far from bear market territory. Meanwhile, credit spreads, which measure the gap in yields between less creditworthy bonds and more creditworthy ones, have resisted any tendency to sprawl dramatically wider, the way they normally do when economic tensions rise and people flock to the safety of more secure debt.
Say what you will, but there is still a fair bit of confidence out there that markets will somehow muddle through. Maybe that is the real reason gold is hanging in there.
Investors may be betting that central bankers will do their best to brake the economy but stop short of steering it into an outright recession, even if that means letting inflation run hot for a while. If so, bonds aren’t the place to be, because inflation will continue to eat at their returns. But stocks won’t be highly attractive either because of a slowing economy.
Gold, in contrast, could hold up well in this stagflationary environment. It would not be affected by a slowing economy because it doesn’t have any cash flows at risk. It could even benefit if central bankers refrain from drastic action and inflation surges higher, bringing down real interest rates in the process.
But investors should be aware of the risks. If central bankers maintain their resolve and keep raising interest rates, come what may, until inflation is vanquished, higher real rates will mean trouble for bullion prices. At its current price, gold is not so much a haven as a gamble on a future of slow growth, cautious central bankers and persistent inflation.
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Ian McGugan