Interest rates as a significant factor
The opportunity cost of keeping gold is one of the major factors that affect its prices. In fact, the movement of interest rates can say a lot about gold’s performance, whether in the short term or medium term. Let us take the recent shift in US interest rates as an example, following Fed Chair Jerome Powell’s testimony to the US Congress.
On the 24th of February, the intra-day movement in gold prices resembled the behavior of the 10-year US Treasury yield. The gold price fell below US$1,785/oz. as the 10-year yield climbed to 1.42 percent, but it recovered as rates fell to about 1.37 percent.
Gold benefited from a large drop in interest rates around the world in 2020. When rates fell to historically low levels, and real rates in advanced economies dropped sharply, gold’s opportunity cost – in terms of rates – almost vanished.
However, as interest rates have risen in 2021, especially in February, this pattern has shifted. The US 10-year yield, for example, has risen from 1% in late January to nearly 1.4 percent. The latest jump was reasonably swift: the US 10-year yield moved 40 basis points from 0.6 percent to 1 percent in nearly five months, but just a little over a month to hit 1.4 percent.
This reflation trade can be blamed for the latest rate movement. Real estate, oil, copper, and lumber have all risen sharply in value, partly as a result of expectations of economic growth, but also in expectations of possibly greater inflation – particularly given the large quantities of money poured into the economy.
Expectations for inflation are also rising. Investors are most likely anticipating a greater (quasi-adjusted) US Consumer Price Index reading in the first quarter. This may be attributed in part to the sharp rise in oil prices, which account for a large portion of the US CPI. If history is any indication, and provided that the price rise would be minimal year over year and will be calculated against its near-0 level in the first quarter of the past year, the US CPI in the month of March could soar to heights that haven’t been seen in about a decade.
While this ‘base effect’ is likely to be short-lived, it can trigger market jitters. However, in the future, a rise in the supply of money and the impact of economic austerity could result in more persistent rising inflation.
In the immediate future, higher rates will appear to be a tailwind for gold, but inflation expectations are also due to go up. Gold has historically done well during high-inflationary conditions around the world. Furthermore, interest rates continue to be conceptually low, despite their recent rise.