What Really Matters for the Surging Price of Gold

Real U.S. government bond yields mostly govern the direction of gold prices, and rallies based on geopolitical distress often fade quickly

By Mike Bird

Gold passed $1,600 per ounce in early Asian trading hours Wednesday, its highest price in nearly seven years.

The rally, sparked by Iranian missile attacks on bases in Iraq where U.S. troops are stationed, is likely to be short-lived unless the conflict begins to affect expectations for the American economy.

Gold’s role as a haven in times of escalating conflict and stress is famous, but over the longer term it’s a poor predictor of the price of the precious metal. Instead, U.S. real yields—the yield of Treasury bonds after stripping out expected inflation—have been the most significant force acting on the price of gold.

Gold rallies based on geopolitical distress usually fade quickly. Photo: neil hall/Reuters 

The relationship isn’t perfect, but the two have a notably close correlation. Every significant move north or south for gold since the financial crisis has been paired with real yields moving in the opposite direction.

The relationship makes intuitive sense: Real yields are a proxy for the risk-free interest rate. If rates increase, they make a speculative asset such as gold, that provides no income, less attractive.

Of course, real yields often indicate panic about something, somewhere in the international economic order. But they’re not always good at that. Last year, gold logged its best year since 2010, rising around 19% as real yields sank, while the S&P 500 rose at the fastest pace in seven years as recession fears dissipated. Gold provided almost no haven in 2008, when the S&P 500 fell by almost 40% and gold ended barely up for the year.

Jeffrey Currie, head of commodities research at Goldman Sachs, noted in research this week that gold rallied immediately after the Sept. 11, 2001, attacks, and in the run-up to both Gulf wars.

But it didn’t hold the gains meaningfully in any of those cases, precisely because the impact on the wider global economy—and real Treasury yields—remained limited.

If conflict between Iran and the U.S. is so severe that it materially affects the expected path of the U.S. and global economies, the move in gold could be sustained.

But that is the channel which will largely decide gold’s movements, not perceptions of geopolitical uncertainty or investor panics.

At practically zero, the yield on 10-year Inflation-indexed Treasurys is already low even by post-financial crisis standards. It can go lower, but investors should be wary of any unexpected change of course in U.S. monetary policy: Ben Bernanke’s unexpected discussions about slowly ending the U.S. QE program in 2013 sent real yields climbing and gold down.

For traders looking at the coming hours, days and weeks, gold may provide a way to trade their views of the short-term cycle of escalation and de-escalation.

For those eyeing a more distant horizon, real yields matter most.

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