All eyes are focused on price of gold right now. Gold has flirted with a peak of $2050 an ounce four times in about forty years. The last time this happened was in early March, as skyrocketing oil prices kindled an inflation scare even as the financial markets expected the US Federal Reserve (Fed) to take a measured approach to rate hikes. A rush to haven assets amid the Russia-Ukraine conflict also underpinned that move.
The same price level was previously achieved in 1980, 2011 and 2020, after adjusting for inflation. The time taken to hit fresh highs has compressed over the years. If the trend holds, we believe it should not take long for breaching the previous record soon.
Inflation-adjusted gold price (USD)
Source: Bloomberg, as of 08.03.2022
Gold’s price in yen is already at an all-time high, with gold in euros and pound sterling close to new highs. And gold priced in other currencies may also follow suit, depending on how fast the dollar value of gold reaches another high. It is true that everyone obsesses over the price of gold in US dollars.
What could trigger a move that pushes gold prices to a fresh high in dollar terms? As in previous instances, real interest rates will hold the key. It is well known that the price of the precious metal moves in the opposite direction to real interest rates. Spiralling inflation kept real rates in negative territory for long.
Interest in gold has increased as people are worried that they may have to contend with a future where their purchasing power is eroded in real terms. For the longest time investors have been able to rely on linear assumptions about the veracity of central bank proclamations and what they can do whether with regard to interest rates or managing inflation. But that assumption will be put to test now as it remains to be seen whether central banks can aggressively tighten their policies without hurting economic growth.
Hawkish rhetoric from some Fed officials is the reason why gold hasn’t yet hit an all-time high. James Bullard, St. Louis Fed president, in April said that a jumbo 0.75 percentage point rate increase might come at some point this year. Gold may face some short-term headwinds as real rates have pushed higher and turned positive recently.
The fallout from the decision by the West to freeze Russia’s dollar holdings has raised questions about the risk free properties of global sovereign debt instruments, to the benefit of gold which is by its nature an apolitical monetary instrument. A variety of factors could once again depress real interest rates in the near term, giving a fillip to gold prices. Inflation, primarily through high commodity prices, may be one factor. If the price of oil goes through $120 per barrel and rises towards $150 a barrel, that could change the bond market’s perspective on inflation being transient. The other way this could happen is if the Fed is unable or unwilling to increase interest rates as much as the financial markets have priced in. The fact that gold prices continue to hover near recent highs shows that investors are sceptical about the Fed’s ability to push up interest rates too far.
Given the above scenario, we believe gold has the best chance to breakout to what would be a genuine all-time high. We expect the previous peak to be challenged over the next quarter and when that happens, it will create much wider participation from investors. The market’s preference for hard and apolitical money over government issued money will be once again reinforced once the price of gold hits a record.
We still expect silver to follow gold. With a breakout of $2100 an ounce we would expect silver to go through $30 an ounce and very quickly challenge its all time high of $50 an ounce.
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