This was a sudden and significant move. Gold volatility also increased substantially; one-year volatility rose from around 10% at the beginning of June to around 14% by the end of the month. Google searches for the phrase “price of gold” rose by nearly 100% in June, indicating the speed, surprise and extent of the gold price surge.
We believe the main impetus for the increasing gold price is the prospect of further aggressive monetary easing by many of the world’s major central banks.
So far this year, the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ) have reduced interest rates because of low inflation. The US Federal Reserve also looks set to cut rates over the coming months, meaning that US real interest rates will lose their positive profile before year-end. Historically, gold prices trade inversely to US real interest rates, and so the prospect of lower US real interest rates is a positive development for the gold price. Because the Fed funds rate is only 2.5%, the extent of possible rate cuts is quite limited relative to previous economic downturns. This means that the Fed may use its quantitative easing policies once again, implying a large tail risk of serious USD weakness and, consequently, significantly higher gold prices over the coming quarters.
The European Central Bank (ECB) indicated it would cut its deposit rate (-0.4%) even further over the coming months. The reduction in the deposit rate reflects muted inflation and weak growth in the eurozone economy. Consensus forecasts suggest that the ECB will cut its deposit rate by between 10 and 20 basis points.
This is a highly constructive development for the gold price, because physical gold storage costs are less costly than the ECB’s negative deposit rate. As a result of this, many investors may be tempted to buy physical gold as an alternative to leaving money on deposit with the ECB. There is also the tail risk of further stimulus measures by the ECB, which will be beneficial for the gold price. In particular, the ECB may resume its quantitative easing programme, and this time the ECB’s QE programme may include purchases of bank debt, not just sovereign debt.
On a global scale, the return of aggressive monetary easing by the world’s central banks is clearly good news for the gold price and raises the possibility of explosive upside moves towards the end of the year, particularly if the world’s major central banks move towards resuming QE. This is not yet being priced in by markets to any real extent.
Finally, many central banks in developing economies are continuing to diversify their reserve mix and gold will continue to account for a larger portion of that mix. The Russian and Chinese central banks will continue to raise their gold holdings over time, and so there will continue to be decent underlying demand supporting the gold price.
Overall, we are fairly positive on gold and expect that its price will easily move towards $1,600 per ounce over the coming year.
Peter Kinsella
Global Head of Forex Strategy