Panic over banks and falling treasury yields have gold prices flirting with an all-time high again. In the short term, a quicker turn by the Federal Reserve may be the deciding factor, but the precious metal’s real success lies deeper. “Gold deserves a structural role in the portfolio.”
Gold prices briefly climbed past the 2,006 dollar per troy ounce level last week. With that, the August 2020 all-time high of 2,075 per troy ounce is getting closer.
Investors are clearly getting nervous about interest rate policy and how quickly the authorities will be able to avoid further turbulence in the banking sector.
Interest rates on two- and 10-year US government bonds fell to 3.62 percent and 3.33 percent last week, the lowest levels since mid-September. Insurance against failures of European banks, especially Deutsche Bank and UBS, found a new five-year high on Friday. Meanwhile, safe havens are crowding.
Investors added nearly 521 million dollars to the world’s largest gold ETF (SPDR Gold Shares) over the past week (through Wednesday), according to data from FactSet.
Gold is ‘indispensable link’
Arjen van der Meer, investor and analyst at Optimix Vermogensbeheer, is enthusiastic about gold. Since spring 2020, Optimix has held a 5 percent position in gold in its neutral portfolio.
The Amsterdam-based asset manager expects continued uncertainty in the coming period. In that case, gold will increasingly be seen as an «indispensable link» in the asset allocation. Gold’s role in portfolio risk management will be «increasingly obvious», said van der Meer.
Interest rates vs gold
Whether gold will really shine is usually heavily dependent on real US government bond yields, a highly volatile asset class at the moment. The ICE BofA Move Index, a gauge of the expected volatility of US Treasuries, is heading towards its 2008 record at 173.6.
Although the Federal Reserve wants to make believe that interest rates need to rise further to fight inflation, the market considers the situation too risky. Four consecutive rate cuts were already priced in on Friday, following a rate break in May.
The US real interest rate on 10-year government bonds now stands at 1 percent. Three weeks ago, it was 1.7 percent. «That 0.7 percentage point drop is the main reason gold is rising at the moment,» said Van der Meer.
Correlation between treasury yields and gold
When US government bond yields fall, the demand for gold usually increases, but that negative correlation seems to be disrupted, for over a year now. While real interest rates have been rising for some time, gold prices have remained flat.
According to Van der Meer, the correlation is still negative, but the coefficient - the extent to which the gold price follows that interest rate movement - is «very limited».
«The gold market is basically saying here: the structural environment for gold is incredibly strong due to high inflation, geopolitical risks, high debt levels coupled with low interest rates and the now ingrained reflex among policymakers to opt for more liquidity and more borrowing at every problem. Therefore, central banks can never sustain this tight policy for very long. As soon as the tight policy ends, the strong bullish forces immediately present themselves again. And so the gold market is willing to sit out this period of tight central bank policy.»
Another explanation, according to Van der Meer, is that gold prices rise over time, and real interest rates may count on «mean-reversion» over time.
Central banks
Another explanation for the high range within which the gold price fluctuates is the increased need for countries to increase their gold reserves.
For instance, central banks’ gold reserves rose in 2022 to the highest level in 50 years, and central banks’ demand for gold rose again in 2023 from where it had left off in 2022, said Krishan Gopaul, senior analyst at EMEA World Gold Council, in a note. Gopaul relies on IMF data, supplemented by buying and selling figures from central banks themselves.
According to van der Meer, there are several geopolitical developments that could potentially be favourable for the gold price. «For instance, the petrodollar is under pressure and the US is waging a war with Russia and a trade war with China, respectively. This could lead to a weaker US dollar, higher inflation and a flight to safe havens, all factors that could push up the gold price.»