Gold prices ticked past $1,800 an ounce this week, and are now not far from the all-time highs reached in 2011, in the bleak aftermath of the financial crisis. New records could be ahead.
Since the financial crisis, the movement of gold prices has been a near-mirror image of movements in the yield on 10-year Treasury inflation-protected securities, which this week touched a seven-year low of minus 0.78%. The ratio between the two assets’ price moves has varied, but the relationship hasn’t broken meaningfully during the past decade.
That makes intuitive sense: An asset with speculative qualities and no yield is somewhat more attractive when yield has all but vanished from safe assets. So the main question for investors is whether real yields will rise or fall—that is, whether they think the economy is likely to outperform or underperform expectations from here.
If fiscal measures to cushion the coronavirus’s economic impact lose political backing, responsibility for sustaining the economy would fall to the Federal Reserve—just as in the years after the financial crisis. That would likely mean lower yields for even longer.
Even with the current substantial fiscal support, the recovery in economic data seems to be leveling off, some Fed policy makers have noted. And that is before even considering what might happen in financial markets if would-be vaccine producers run into difficulties.
So far, signs of inflation from disrupted supply chains or aggressive monetary support have been largely absent. But even if inflation were to tick higher, reducing real yields further, it is difficult to imagine the Fed raising interest rates, given parlous economic conditions generally.
Another factor to consider: Who is buying all this gold? Inflows into gold exchange-traded funds in the first half were the largest ever, and largely from North America. Flows into gold from institutional investors in developed markets have predominated, with emerging-market demand comparatively weak, Goldman Sachs researchers noted. They expect a pickup in the latter as consumer demand improves in developing economies later this year.
And while it is possible developed economies will recover faster than expected, a recent surge in U.S. coronavirus cases show the limits to reopening during a pandemic. Some parts of the world that had kept cases down, like Australia, are experiencing second-wave wobbles.
A negative case for the price of gold would require a much more optimistic economic outlook, or an unlikely shift in focus from major central banks. Without either it is hard to see gold falling much, and it isn’t unreasonable to believe it will reach new highs in the months ahead.
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