Free | Global Macro & Strategy | Investment Ideas

Gold trending higher and what’s driving it

Gold is one of those assets that has a lot of misinformation around it. It gets promoted by some as something to be held when fear grips the market, or as an ‘inflation hedge’. Whilst these generalisations have some grains of truth to them, they are fairly clumsy in terms of real world application. And that’s not even mentioning the ‘clickbait’ predictions of Gold skyrocketing to the moon as fiat currencies collapse.

The reality of Gold is that it depends on two factors – the level of bond yields, and the expected rate of future inflation. In other words, it tends to trade in line with real yields (the US 10 year bond rate minus the 10 year breakeven inflation rate).

The graph below shows the inverse relationship. Notice how the gold price rises as real yields fall.

Regime transition

Gold has had a tough time of it in the past year. As the global economy recovered from COVID shutdowns and went into the ‘reflation’ regime in the latter half of 2020, Gold has underperformed (as it usually does in that environment – hence the importance of knowing the macro environment). Whilst the S&P 500 is up +35% over the past year, the Gold price (in US dollars) is down -8%. That is quite the underperformance.

However, as we have been highlighting in the weekly Portfolio Strategy Update for a number of weeks now, the economic regime is in transition, and reflation is not the regime that the markets are trading with now. The market is looking ahead and seems to be building in a case for growth slowing, with inflation remaining sticky and higher than usual. That is a good place for Gold as it means bond yields stay anchored on growth slowing concerns, while inflation expectations can move higher (hence real yields lower).

Inflation expectations creeping higher again

Indeed, as seen below (this chart updates daily in our Portfolio Strategy Update section) the US breakeven inflation rate peaked in mid May, fell through to mid June, went sideways in a range for a month, and looks to have broken out of that range to the upside again as the market starts to have serious doubts about the Fed’s assertion that inflation is transitory.

The chart below is the Gold price itself (which is also updated daily in the Portfolio Strategy Update).

As you can see, it was a horrible run from early August 2020 to early March 2021 as reflation dominated the landscape and Gold got stuck in a consistent downtrend. However, Gold has since put in a bottom and a couple of higher lows, and has transitioned into a positive trend. This reversal in price action and trend is coinciding with the aforementioned transition in macro regime, providing the underlying fundamental backing for the price action.


Author: Graham Parkes
Macro analyst & editor of The SMSF Investor

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