After scoring a new all-time record high last Friday, gold prices have remained generally upbeat. This is an unusual situation for the historic trends for gold. That doesn’t mean that the price is necessarily about to reverse, but there are some potential warning signs that new record highs might become more difficult.
The issue is that gold normally correlates inversely with dollar interest rates. That’s because gold doesn’t pay dividends, and works best as a hedge against inflation. With interest rates above the inflation rate, then it’s more profitable to hold treasuries than gold. Which is the current situation, as the benchmark US treasury has a yield of over 4.75% while inflation was last reported at 3.2% annualized.
What’s Driving the Mood?
But inflation has been on the rise, which has left the Fed talking about keeping rates higher for longer. If investors actually expect inflation to stay higher, then the higher price of gold could be justified, as they hold gold to offset inflation expected to rise higher than interest rate. However, there is a pretty solid consensus that if inflation were to trend that high, then the Fed would have to raise rates as well.
The thing is that as the normal pressures for gold would have led it lower, something else has interfered to keep the price higher. If that issue is resolved, then the price of gold could relatively rapidly “normalize” lower.
Why Should Gold Be Lower?
The price of gold originally appreciated as markets expected the Fed to cut rates. At the start of the year, the market was pricing in as much as six rate cuts, starting as early as March. Well, that didn’t happen. Now the first rate cut isn’t expected until September. And the market is not even sure there will be two rate cuts. There is just a 54% chance of 50 bps of easing, down from the 300 bps initially expected.
Naturally this pushes yields higher, and gold would be expected to price somewhere closer to $2,000/oz, like it did back before the market got overly enthusiastic about rate cuts. What’s stopping the price from falling, and indeed, pushing it to new highs, is geopolitics. Specifically the situation in the Middle East.
Prices Rise With Tensions
The markets appeared to be calming down after the latest salvo in the Middle East, when Iran launched hundreds of missiles at Israel. After virtually all of them were shot down with little damage, the expectation was that the situation could slowly de-escalate. But, for now, the rhetoric remains heated.
Israel said it would respond to the missile barrage, but didn’t provide details. There has been rampant speculation that Israel could target Iran’s controversial nuclear program. In light of that, Iran recently said it would respond to an attack on its nuclear facilities by targeting Israel’s nuclear weapons.
There is no way the markets will be calm if military commanders in the middle east are throwing around the word, “nuclear”. Just this morning there were air raid sirens and reports of explosions in Isfahan, Iran. As the dust settles on exactly what happened there, the price of gold will likely remain elevated at least in the short term.
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