The past 12 months have been baffling for gold investors. Inflation has been the topic of the year, yet the yellow metal has lacked positive momentum. There has been an unusual divergence between gold prices and real interest rates that needs some context and explanation.


Diving straight into the technicals, we can see (Figure 1) that the gold price in dollars is still looking for direction within a narrowing wedge. We can certainly expect substantial volatility (with an upward bias in due course) once this choppy sideways action finally ends. That catalyst for directional change in the gold price looks to me most likely to be driven by overreach — an over-hawkish policy error at the US Federal Reserve (Fed).


Inflation is still priced as though it’s going to disappear, despite it no longer being contained to a narrow range of items and despite the attempt to erase the word “transitory.’’ 

Optimistic Fed 

That inflation is a mirage seems improbable of course but need not be our focus. If the market does wake up to embedded inflation and that feeds through into real interest rates, it would be pure upside for gold investors, but for now it’s not the main game. The market’s focus in terms of real rates and gold is centred on tightening expectations, as expressed through Fed rate hikes, and tapering of asset purchases.


This summer, real rates and the gold price diverged, just as the gold prices looked to be breaking out (see arrows in Figures 1 &2). This divergence began with the first mention of tapering and has remained solidly in place ever since (Figure 2). The second half of this year feels similar to 2012-2016, when the Fed promised endless hikes and even the normalisation of its balance sheet. That was a guidance ruse, aimed at maintaining control of the bond market, just as this year’s promise of a series of hikes and rapidly tapered asset purchases seems very optimistic.

Hawkish to dovish 

The punchbowl surely can’t be removed for long as investors have been gorging on high duration and risk assets for almost two years now. Unless we are to imagine that there will be yet more hikes than are priced in now and an even faster taper than currently priced in post the December Fed meeting, it seems hard to imagine anything other than some form of hawkish-to-dovish reversal coming down the pipe. 

Figure 1 – US$ Gold Price 

General Powell’s Last Stand? - Chart1

*Source: Bloomberg, as at 15/12/2021 

Figure 2 – USD real rates and USD gold uncoupled when the Fed began talking about tapering 

*Source: Bloomberg, as at 15/12/2021 

I would also mention that numerous interest rate hikes and a speedy taper are already priced in. It is arguable whether such a ‘policy-error’ driven selloff in equities and risk assets would even create a substantial move lower for gold should it happen. Normally one would expect a selloff in risk assets to lead to a spike in real rates due to collapsing forward inflation expectations, but in this instance, I could envisage a scenario where the priced-in hikes and taper dissolved quickly, driving real rates to fresh lows. This of course would be very bullish for gold prices.


Heading back to our favoured historical analogy — the 1970s — periods where real rates are low and even falling while gold pauses are part of the story. As shown in Figure 3, in late 1978 real rates were on a long march down, but gold chopped sideways and lower for a few months before it reacted, eventually exploding higher in 1979. 

Powell’s last stand? 

This last six months feels and looks like a last stand for hawkish guidance and promises before the Fed has to put up or shut up. What happens next will be much more important than what happened in the past 12 months. Many believe the Fed is on the brink of a major policy error by tightening monetary policy into a slowing economy. I am aligned with that view.


A bit like that shaded period in late 1978 (Figure 3), I would characterise the current period as being analogous to the romanticised story of ‘Custer’s Last Stand’, a story that was one of hubris and overreach on General George Custer’s part. At the Battle of Little Bighorn in 1876, Custer and his 700 men took on and were soundly defeated by a few thousand Sioux and Cheyenne warriors.


Similarly, the Fed can posture, threaten and attempt to hold its line using language and promises, but when it comes to seeing the whites of the enemy’s eyes – making the actual policy moves — my sense is a rapid retreat will follow.

Figure 3 – USD real rates and USD gold have uncoupled before 

General Powell’s Last Stand? - Chart2

*Source: Bloomberg, as at 15/12/2021

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