The fall in the price of gold, as well as stock markets, is most affected by the diverse developments in the bond market, as the yield on a 10-year US bond is approaching 1.5 percent. This is a negative sign for stocks, as increasing bond yields raises the cost of capital for companies and their value. It also has a negative impact on the price of gold, as bonds to large financial institutions are in direct competition with gold when it comes to a safe harbor. The "ownership" of gold represents an opportunity cost for them, so they prefer to intervene in bonds in the short term. But for how long and what might happen in the future?
I believe that the rise in bond yields is only temporary, as I expect the US Federal Reserve to intervene soon and stop its growth through Yield Curve Control. Why? If the US central bank allowed bond yields to rise further, liquidity support to the economy would be reduced, which would have a very negative impact on companies and their share prices. In this case, we would soon see the beginning of declines in stock markets, and with it panic in stock markets and problems in economies around the world. This cannot be ruled out, but such an event could again be compared to the appearance of the "Black Swan", which a year ago represented the arrival of a new coronavirus for the financial markets. The event had a negative impact on the entire financial sphere.
Yield trends of a 10-year U.S. bond over the past 35 years. Source: Guggenheim Investments / Bloomberg
Gold is affected by movements in real interest rates
Gold reached its highest value in history in August 2020, followed by the expected and healthy consolidation in price. The jump to a higher level was somewhat slowed down by the aforementioned increase in bond yields. This begs the question, why does the price of gold fall when bond yields increase?
The movement of the price of gold is strongly linked to inflation expectations, and at the moment it is also extremely important that gold is affected by the movement of real interest rates. Therein also lies the reason that gold prices have been falling recently. The real interest rate reflects the value of the purchasing power of the interest we paid for the investment or loan. The definition of the calculation of real interest rates reads: Real interest rate = nominal interest rate - inflation The nominal interest rate means the percentage increase in the money you pay the lender to use the money you have borrowed. Inflation, on the other hand, is the growth rate of product prices.
At the same time, the realization is important. When nominal interest rates (bond yields) are higher than inflation, positive real interest rates occur, which negatively affects the price of gold. When nominal interest rates are lower than inflation, negative real interest rates occur, which has a positive effect on the price of gold. For a higher price of gold in the future, the key question is whether we are entering a period of inflation or not.
Inflation is at the door. What will happen to the price of gold?
In the next period, we can certainly expect two important changes, which may have an extremely positive effect on the price of gold. For the stability of financial markets, the US Federal Reserve will have to resort to controlling bond yields. However, we can also expect that higher commodity prices and the momentum of the world economy will mean the arrival of inflation and rising consumer prices. As a result, it is realistic to expect real interest rates to rise again in the future with rising inflation, which is an ideal environment for gold and its price.
Gold price profitability trends over the last 55 years by months. Source: LBMA
The current price of gold creates very good (re) entry points before its growth continues. This is also confirmed by the movement of gold by months in the last 55 years (graph below), as in the past the very beginning of the calendar year offered the best entry levels for buying gold. How long and at what values they will be available at the moment, of course, also depends on the US Federal Reserve and its monetary policy. But in the current period, they are going to be put to good use, as it shows time and time again how much we start to miss good purchase points when they are no longer there.
Photos are taken from pixabay.com.
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