Ten-year bond yields have risen by around 80 bps since January, to levels of around 1.70%, meaning that US real interest rates will not be deeply negative as previously feared. The bull case for gold was predicated on having persistent and compounded negative real interest rates over the coming years.
The buoyant mood in global equity markets has also aided gold’s decline, because investors have sold gold and purchased cyclically sensitive equities. Gold-backed exchange-traded funds have seen outflows of around $13 billion since October 2020, and the latest CFTC data indicates that investors have reduced net long gold positions significantly in recent weeks. In a sense, markets have flipped from a consensual long gold position towards a more pessimistic outlook.
Short-term risks are on the downside.
The US Federal Reserve raised its growth and employment forecasts, confirming the market’s suspicion that risks are no longer tilted towards further monetary policy stimulus measures. The options market now shows a great bid to gold puts in the short term, meaning that investors have discounted the possibility of further aggressive gold price rises.
Because the Fed has raised its growth and inflation forecasts, there are upside risks for US yields and the corollary of this is that further modest downside in gold is feasible. This may result in a down move to levels of around $1,650, but we do not think that gold will trade lower than this, because the lion’s share of yield-steepening has now taken place and is fully priced in by investors. Additionally, we expect that the USD will decline significantly over the coming quarters, due to the widening twin deficit which comes to 20% of US GDP.
We anticipate that as the USD weakens, gold will benefit because it is priced in dollars.
Further downside below $1,650 is unlikely. Central banks around the world will continue with aggressive monetary stimulus measures and there is no chance of a return to sound money principles on a wider scale. Indeed, despite the rise in US yields, the Fed is still engaging in $120 billion worth of quantitative easing asset purchases every month. Once growth and inflation dynamics return to pre-pandemic trends, central banks around the world will be forced to maintain an incredibly loose monetary policy stance, and this is bound to support gold over the longer term. In summary, we think that gold will trade in a range of $1,650 – $1,800 over the remainder of the year.