- Expectations of continued monetary and fiscal stimulus continue to suppress U.S. real interest rate expectations providing fundamental support to gold prices from a short-term perspective.
- From a long-term perspective, gold is elevated relative to consumer prices and the broad commodity complex.
- We expect gold prices to remain supported while consumer prices and the commodity complex play catch-up in line with the surge in government debt and money supply.
Short-Term Drivers Point To New Highs
The most important driver of gold from a short-term perspective is expectations of real interest rates. These expectations simultaneously drive the yield on 10-year inflation-linked bonds as well as gold prices, and the relationship between the two is very close as the chart below shows. Spot gold is trading almost exactly in line with the level implied by real yields based on this 15-year correlation, with Friday’s new 7-year closing low in real yields suggesting new highs in gold in the near term.
Source: Bloomberg, Author’s calculations
Inflation-linked bond yields can be dissected into nominal bond yields and market-implied expectations for consumer price inflation. The new multi-year low in 10-year inflation-linked bond yields (lower panel on chart below) has been primarily driven by declining nominal yields. In fact, inflation expectations have fallen by around a full percentage point since the last time real yields were this low back in 2013. Gold prices have actually been inversely correlated with inflation expectations over the past few years, as the trend of disinflation has been met with even sharper declines in nominal yields.
U.S. 10-Year Yields Vs Breakeven Inflation Expectations
More recently, however, the decline in real yields has reflected the rise in inflation expectations, with breakevens rising 80bps since the March low. There is a limit to how much further nominal yields can head given the already low yield, so any future gold price gains are likely to become heavily dependent on rising inflation expectations. Fortunately for gold bulls, there is considerable upside potential for inflation owing to the Treasury’s insatiable appetite for debt issuance and the Fed’s willingness to buy it.
Long-Term Drivers Suggest Gold Bull Reliant On Rising Inflation
In order for gold prices to rise over the long term, we will need to see consumer price and commodity price inflation rise. Gold is ultimately a store of value, and in the absence of high consumer and commodity prices, its appeal should decline. The deeply depressed nature of real interest rates has effectively caused gold prices to overshoot to the upside relative to the commodity complex and consumer prices, as investors have bought in anticipation of rising consumer and commodity prices in the future.
XAU vs. Continuous Commodity Index
If we are wrong in our expectations of a return of high inflation as explained here, then gold prices will likely perform very poorly. The ratio between gold and the CCI (continuous commodity index) remains close to all-time highs, and should we see deflation as some analysts expect, then gold prices should decline. We saw this in March when deflation fears surged amid the dollar shortage.
What is more likely, in our view, is that gold remains elevated and drifts higher in response to continued declines in real yields while commodity and consumer prices play catch-up. The explosion in government debt and money supply should ultimately begin to be reflected in higher prices for everyday goods and services.