Interest rates are falling, right? Not if you consider the position with real interest rates, those after allowing for inflation. They’re rising, and gold is paying a price by dropping $200/oz over the last two weeks, with worse to come.
The problem for gold, and a looming problem for the broader economy, is that a deflationary spiral appears to have started, triggered by the collapse in the price of oil and magnified by coronavirus shutdowns.
An employee arranges one kilogram gold bars at the YLG Bullion International Co. headquarters in … [+]
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In normal times gold would be surging higher on news of official U.S. interest rates plunging to near 0%. U.S. rates are gold’s arch-enemy given its status as a non-interest bearing asset.
But when the gold price turned south earlier this month analysts were forced to reconsider everything they had learned about the metal which plays a role as both a commodity and a currency.
Macquarie, an Australian investment bank, was first to notice gold’s reversal in a note which considered three “bear” factors influencing gold which were likely to cause a price fall despite global economic uncertainty and low interest rates — a perfect recipe for a rising gold price.
But what Macquarie saw was a trio of problems that included the rising value of the dollar as investors shifted funds to safe havens, margin calls on loans which are exposed to assets falling in value, and “falling inflation expectations”.
A bear market for gold might have started thanks to rising real interest rates triggered by falling … [+]
Of those three bears the biggest is the dramatic shift in inflation expectations driven by the collapse of the production and price rigging deal between Russia and Saudi Arabia which led to a collapse in the price of oil.
Macquarie said that inflation expectations had declined throughout 2019 but gold moved higher because falling nominal interest rate yields (before allowing for inflation) were the dominant driver of real yields (after allowing for inflation).
“Real yields still fell (during 2019) because nominal yields fell more than inflation expectations,” Macquarie said.
Real Yields Bouncing Back
“In the past week, however, despite nominal yields continuing to decline, real yields have bounced back from their lows.
“The last time the market suffered such a dramatic collapse in inflation expectations, with real yields rising rapidly despite steady nominal yields, was during the global financial crisis (of 2008). In that period, gold corrected by 30%.
“A repeat of 2008 would see gold pull back to below $1200/oz. Nothing is impossible but we do not view this as a plausible scenario.”
Despite Macquarie’s optimism that a fall below $1200/oz is unlikely the bank warns that a further rise in real yields, driven by the oil-price decline and fears associated with the coronavirus could be the catalyst for a meaningful correction in the gold price.
“The additional kicker would be a flip to a stronger dollar, a risk our foreign exchange strategists see emerging once Federal Funds hit zero.”