There are no two ways about it: gold prices exceeded our expectations in Q1’22. Our rationale for not taking up price projections on gold is, and remains strong: central banks, including the Federal Reserve, have begun to halt pandemic -era stimulus efforts, with a new cycle of rate hikes beginning.
At least in the short term, a strong catalyst arrives that surpasses expectations of interest: the Russian invasion of Ukraine. With global financial markets rising and the commodity supply chain in disarray, inflation expectations soared again. Instead of increasing actual yields, we saw actual yields fall from mid -February to late March.
Unfortunately, with the prospect of a Russia-Ukraine ceasefire gathering steam by the end of Q1’22, there is a possibility of sanctions against Russia being lifted, thus removing pressure on the global commodity supply chain. On the other hand, inflation expectations could back off, and consistent with the central bank’s long -term narrative of raising interest rates, real yields could start to rise again.
That’s where the challenge for gold prices in Q2’22 lies: unless there is a dramatic escalation in the conflict between Russia and Ukraine that has plunged the European Union and the United States into a protracted dispute, the catalyst that has driven gold prices higher in recent months is likely to age short.
Actual US Results Proven Problematic
Despite the disruption posed by the Russian invasion of Ukraine, the same obstacles remain for the price of gold from now on. With central banks acting to reduce continuously higher realized inflation in the short term, long-term inflation expectations will begin to decline, pushing up real yields and thus preventing gold prices from maintaining recent gains.
Gold, like other precious metals, has no dividends, yields, or coupons, so the increase in real U.S. yields remains problematic. In other words, when other assets offer better risk -adjusted returns, or more importantly, offer significant cash flows during peak inflationary pressures, then assets that do not generate significant returns are often unpopular. Gold behaves, in fact, like a long -term asset (as measured by the modified period, not the Macaulay period); zero coupon code.
US Treasury Gold vs. Nominal Futures (Chart 1)
The facts on the field have not changed and will be of greater influence if the Russian aggression on Ukraine is stopped. The monetary easing enacted by the central bank and the fiscal stimulus provided by the government are now clearly reflected. A ceasefire between Russia and Ukraine will relieve pressure in food and energy prices, which in turn will help reduce inflation expectations. But given how high inflation readings are in economies like the EU, the US and the UK, central banks will still raise interest rates aggressively throughout 2022.
It is therefore reasonable that the actual rate hike be a meaningful obstacle to the price of gold in the coming months. Over the past five years, gains by U.S. real yields have generally been linked to losses by gold prices. A simple linear regression of the relationship between the weekly price change in the price of gold and the weekly base point change for the US 10 -year real yield, revealed a correlation of -0.34. As a rule, an increase in real yields is bad for the price of gold.
Except for World War 3, it’s hard to imagine how the environment would have become more attractive to the price of gold from a fundamental perspective. Yes, there has been talk of how EU and US sanctions against Russia threaten US Dollar hegemony, which could eventually trigger more countries to abandon USD -denominated reserves and instead allocate more reserves to gold. But that’s a long -term story, which won’t happen in the next quarter, or even a year, especially since over 40% of global trade continues to be denominated in USD (and another 35% in EUR).
In short, the price of gold has two possible paths forward: sideways (as Russia’s invasion of Ukraine continues, maintaining expectations of rising inflation when the central bank raises rates, maintaining the status quo in real revenue); or lower (when the Russian invasion of Ukraine ended, inflation expectations declined when the central bank raised rates, driving real yields higher).