This post is the first in our Macro Research Bites series, which breaks down evolving macroeconomic trends into short, digestible pieces. Each post will also exist in thread form, shared on Twitter/X. As always, we’d love to hear your feedback — and, remember, none of this is financial advice. More below!
Historical Precedent
Gold has long been negatively correlated with real interest rates. A study in the mid-2010s, for instance, found the correlation to be as high as -0.82.
The traditional explanation for this phenomenon is that when real rates are positive, the opportunity cost to hold gold is high because it doesn’t pay any dividends or interest. However, under lower rate conditions, capital flows out of yield-bearing assets like bonds and into assets like gold.
Recent data, however, shows a break from this pattern. Since 2022, the price of gold and (inverted) real interest rates have increasingly diverged.
Visualized another way, it’s clear to see that as real yields fall (candlesticks), gold prices increase (orange line).
The area shaded red highlights the current situation, where we would expect gold to have sold off much more under the usual strong correlation.
This change of pattern begs the question — has the relationship between gold and real rates broken? If so, why?
Potential Explanations
We’ll posit a few potential explanations for gold’s remarkable continued performance despite the rapid rise in real rates over the last two years.
1. Central banks are buying gold
2022 saw central banks making the highest net gold purchases in over 70 years. Emerging economies — Russia, India, China, Turkey and others — made up a majority of these purchases.
Gold has long been viewed as safe haven asset during turbulent times. In a world faced with increasing geopolitical uncertainty, demand for gold rises.
2. Inflation expectations remain high despite rate hikes
Central banks are not the only buyers propping up demand for gold.
Despite the meteoric rise in rates, inflation expectations have not declined as quickly. Given that many consider gold an inflation hedge, investors may be continuing to hold on to gold through rate hikes in the hopes of protecting against slowly declining inflation, or, worse, a resurgence in inflation akin to what took place in the latter half of the 1970s. However, as we’ll cover in a future blog post, gold may not be quite the inflation hedge many seem to think.
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The now consensus view that Central Banks are nearing the end of the tightening cycle suggests a forward-looking investor should begin accumulating gold, with the expectation that soon-to-decline real yields will drive new inflows (assuming the historically inverse relationship between gold and real rates returns).
Elevated real yields’ domino effect on global economies and their credit conditions may serve as a further catalyst for concluding the tightening cycle, and soon. The BOJ, for instance, is already suspected to have intervened several times to try to protect the yen.
4. The commodities supercycle
Equities and commodities alternate leading the market in approximately 18-year cycles (see e.g. Bannister and Forward), in line with deflationary and inflationary cycles. At present, we are nearly 15 years into a deflationary/equity-leading cycle beginning in 2009; see chart below.
Geopolitical turmoil, supply chain and transport disruptions, chaotic attempts at transitioning from fossil fuels — and the uneven changes to demand for oil, natural gas, and metals like Lithium and Nickel, critical to battery production — may accelerate this transition to a new commodities supercycle. Persistent gold holders may be betting on this shift.
What Next?
If gold fails to return to its historically inverse correlation to real rates, we may in retrospect point to one of the major shifts above as the cause.
We’ll continue our focus on gold next week, with a piece on the asset as an inflation hedge (hint: conventional wisdom here may be wrong).
Finally, whether you’re a gold bug or an oil aficionado, there’s now a place for you to trade these assets on-chain (last hint: look no further!).
Read the original version of this post, published on our Medium blog Oct 19th, 2023, here.
