What is happening to #gold prices? As the precious metal has no yield, its price is typically inversely correlated to real interest rates, i.e. the opportunity cost of allocating capital to gold. Yet this relationship appears to be broken. While real rates as measured by the yield of inflation linked bonds are still elevated, gold managed to rise 19% since its Nov ’22 low. The magnitude of the divergence is unprecedented in recent history (see wkly chart w/gold price inverted).

One possible explanation is that the gauge may be broken. In other words, after decades of intervention, real rates are no longer capable of measuring the monetary regime and that far lower real rates lie ahead. Such explanation would be consistent with “yield curve control” scenario where the Fed resorts to cap yields regardless of the level of inflation so as to keep the cost of funding government debt low relative to gdp.

Another possible explanation is that the drivers of gold demand have changed and the marginal buyer is no longer sensitive to the opportunity costs associated with it. Such explanation is consistent with the data showing that #centralbanks have last year accelerated gold purchases. These countries are typically #commodity exporters with large current account surpluses whose appetite for Treasuries and other USD-denominated assets has dwindled and see gold as an attractive alternative. To this regard, the Feb 26th Ukraine sanctions were a game changer as opined on these posts (https://bit.ly/3ZSouyl) and China, India, Saudi Arabia/GCC countries etc, recognized their USD reserves make them vulnerable to possible changes to US foreign policy.

These countries collectively hold approx $6.0 trillion in foreign reserves but only about 7% of those reserves are in gold. The same countries generate additional surplus every year, part of which needs to be deployed into foreign-denominated reserve assets. On the supply side the available annual production at current prices only amounts to $100-120 bil. Should central banks want to increase their gold reserves, say, to 20% of total, the ensuing demand may double prices from the current levels.

Lastly private investors have yet to fully embrace gold allocation. Total private gold investment excluding jewellery, is estimated at less than $3.0 trillion or approx 1% of global wealth excluding property. As global investors come to terms with the inevitability of currency debasement and historically elevated sovereign instability, allocation to gold will rise and so will its price.

Disclosure: Not investment advice. Do your own research. Hold all assets mentioned. Twitter @pietroventani for more timely comments and updates

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