Speculative investors must find something else to justify further increases in gold prices.
Photo: David Gray/Bloomberg NewsAfter a meteoric ascent over the past year, the price of gold has tumbled again this week, dropping back below $1,900 a troy ounce.
That hasn’t fazed analysts. Bank of America, for example, has an 18-month gold price target of $3,000. Investors should be more cautious: The close relationship between real U.S. interest rates and gold suggests that the yellow metal needs a new driver to reach dramatic new highs.
Over the last decade, there have been 19 occasions in which 10-year Treasury inflation-protected securities have risen by more than 5% in price—meaning that real yields are tumbling—over the space of 10 weeks. In each of those periods, gold prices have risen significantly, but never as much as the 21% they have increased in the past 10 weeks.
So by the standards of recent history, gold has already risen quite a lot.
The 10-year Treasury yield sits at 0.66%, implying that there is almost no expectation of any meaningful increase in interest rates over the next decade. The 10-year break-even inflation rate has climbed back to 1.63%, around the level at which it spent most of 2019 and just shy of the 1.78% average for the five years before 2020.
Real interest rates can certainly fall further, but unless there’s a sharp change in investors’ views about the inflation to come, the lion’s share of the decline is likely to be over. So speculative investors must find something else to justify further increases in gold prices.
The best argument that the yellow metal can disconnect from its relationship with the bond market comes from 2011, when gold prices moved far more sharply at times than the move in TIPS yields would have suggested, and when gold had already risen considerably in 2009 and 2010.
Investment advisory firm Crossborder Capital believes the link between real rates and gold, to the extent that it holds, is confounded by a third factor: liquidity. It expects the surge in the U.S. money supply to push gold prices to at least $2,500—and possibly as high as $3,000—a troy ounce before late 2021.
Extreme shifts in markets—as now—are precisely when long-held relationships are stretched, and so it’s impossible to write off such dizzying new heights entirely.
But if they are to be reached, gold’s existing relationship with real rates will have to be stretched to the point of destruction. Bulls betting on big further increases should be aware that, as opposed to earlier this year, history is no longer firmly on their side.
Write to Mike Bird at Mike.Bird@wsj.com
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