In predicting the price of gold, most market observers look at the US dollar as a clue because it is the currency in which gold and most other commodities are priced, helping to explain the inverse relationship between the yellow metal and USD. Others look inflation expectations, whereby rising inflation means a relative decline in the value of money, allowing for gold to act as an alternative of value preservation. This also means that rising interest rates generally mean weaker gold and vice versa. As these 3 dynamics interact, they help explain why real interest rates are more crucial in assessing gold’s movements.
Real interest rates
Instead of looking at interest rates or bond yields, we must look at the “real” level of interest rate, or interest rate minus inflation. It does not matter how high-interest rates and bond yields are if their level is not high enough to make up for the level of inflation. When gold hit an all-time high above $1900 in September 2011, the yield on US 10-year government bond was at 1.90%. Four years later, when the yield stood at the same level, gold fell 37%. The reason to gold’s plunge despite similar yield was that inflation fell to 1.2% in 2015 from 1.7% in 2011, lifting the level of real bond yields to 1.2% in 2015 from 0.2% in 2015.
Dismal Inflation
The Federal Reserve’s main gauge of US inflation has fallen to 1.3% in August from 1.9% in October last year, despite a 12% decrease in the value of the US dollar over the same period. The Fed views inflation weakness with bemusement and has persistently (and inaccurately) predicted a rebound over the last 6 years. Considering the Fed’s plan to begin withdrawing the asset-purchasing stimulus it created since 2008, prospects for inflation to rebound towards the 2.0% target are slim. Factoring in the ECB’s intention to reduce asset purchases and the anticipated rate hike from the Bank of England, inflation expectations will not be running way soon.
