Is Gold’s Surge a Safe Haven Trade, or Speculation?

Real yields, or rates, are simply the current yield of a Treasury bond minus the rate of inflation or expected inflation. Real yields serve as a measure of the looseness or restrictiveness of monetary policy: The higher a real yield, the more restrictive monetary policy is, and vice versa.

The graph below shows the current level of real yields, which are at their highest in 15 years. Accordingly, it’s fair to claim that, regardless of how the Fed may have shifted its stance in recent months, monetary policy remains very restrictive:

In our article, “The Fed’s Ever-Growing Golden Footprint,” we explained why this historical relationship between gold and real yields existed:

The level of real interest rates is a sturdy gauge of the weight of Federal Reserve policy. If the Fed is treading lightly and not distorting markets, real rates should be positive. The more the Fed manipulates markets from their natural rates, the more negative real rates become.

In that article, we divided the last 40 years into three periods, each based on the level of real yields:

Before 2008, there was no statistical relationship between gold prices and real yields. However, as the Fed's monetary policy became more aggressive in 2008, the correlation between the two tightened. By the time the Fed had begun to reduce its balance sheet in the QE2 era, gold and real yields had developed a significant correlation, with an R-squared of 0.7865:

Building from our previous analysis, it’s unsurprising that the correlation between gold prices and real yields has faded somewhat, given our current environment of high real yields. However, without real yields steering the price of gold, we must consider other explanations for why the price of gold has risen so rapidly.

Let’s consider each in turn:

Explanation #1: Fiscal Imbalance

The federal government is running large deficits. As shown below, the annual percentage increase in federal debt is over 8%:

Such significant deficit spending occurs as economic growth is running above its natural growth rate and prepandemic levels. Typically, deficits tend to be lower during periods of economic growth and bigger during recessions or economic slowdowns.

That said, the recent increase in debt growth is significant, but not much more so than other nonrecessionary peaks in the last 10 years. Additionally, it is well below the debt increases associated with recessions. A deficit of more than $2 trillion sounds daunting, but the economy has grown by 33%, or $7 trillion, since 2020; it’s doubled in size since 2009.

The graph below, showing the debt-to-GDP ratio, helps put more context on the rate at which the government borrows:

This upward-trending debt-to-GDP ratio is not sustainable. However, the current ratio and slope of the recent trend line align with the trend going back 20 years and even longer.

We have written many articles on the problem of debt growing faster than GDP and the economic damage it is doing and will do. However, when placing current deficits into proper context with the pace of economic activity, the recent growth is not glaringly different from other experiences of the last 20 years.

As such, we find it hard to believe that debt is responsible for gold’s recent run-up.

Explanation #2: Geopolitical Issues

The geopolitical situation, especially regarding Ukraine and Israel, is indeed tense, and it’s difficult to predict the trajectory along which these conflicts will evolve. Many analysts have expressed concerns of nuclear weapons deployment or the expansion of war to neighboring countries, which could spiral into a broader global conflict.

Not to minimize the severity of these two geopolitical events or others, but the U.S. and Europe have been engaged in various wars in the Middle East and Afghanistan for most of the last 20 years. Is today's environment that much more frightening than in years past, such that it would have an outsized impact on gold’s price?

As we started writing this, on April 4, 2023, rumors that Iran might be planning attacks against Israel resulted in the S&P 500 index falling by more than 1% and gold’s price falling by $25/oz. If geopolitical concerns have driven the yellow metal’s price higher, shouldn't increasing tensions in the Middle East have further added to gold's value, rather than the opposite?

Given these observations, we also find it hard to believe geopolitics are responsible for the recent rise in gold prices.

Explanation #3: Inflation

Some argue that higher gold prices are a warning that the lower inflation trend of the last 30 years is reversing.

To that we say, if gold is such a good predictor of prices, why did its price go nowhere when the Federal Reserve and government rained money on the economy and supply lines were shut down? After all, that period represents the most significant inflationary setup in over 40 years:

Explanation #4: A Dovish Fed

Since late last year, the Fed has flipped from an uber-hawkish tone to a more dovish one. Despite easy financial conditions, high and sticky inflation, and above-average growth, the Fed seems intent on cutting rates multiple times this year. (Many would argue that a more prudent Fed would maintain its hawkish tone and possibly consider increasing rates further.)

As we showed earlier, monetary policy, while seemingly becoming easier, remains at its tightest levels in over 15 years. Compare monetary policy today to that in 2013 and 2014. Back then, the economy was growing, yet the Fed had rates pinned near zero percent and was engaging in QE. Yet, as seen in the chart below, gold languished during that period, despite complete monetary policy carelessness:

So we think it's a bit of a stretch to claim the Fed's less hawkish tone is the impetus behind the recent rally in gold prices.

Explanation #5: Speculation

Having fact-checked some of the standard lines that pundits use to explain gold’s ascent, we share one that may not be as popular with gold holders: Gold is a speculative asset. Accordingly, it can rise and fall — at times violently — based solely on the whims of traders and speculators.

Might the current surge in gold prices be less a function of the fundamentals raised above and more the result of speculative mania flowing through many markets?

Consider the graphs below, which illustrate solid statistical correlation over the last two years between gold and bitcoin, Nvidia, Meta, Eli Lily, and the S&P 500 index:

Summary

In this article, we reviewed some of the typical rationales used to explain higher gold prices. While they may sound like legitimate explanations for higher gold prices, when we look at the data in context, we see that not much is different now than from other periods in the last 20 years, when the previous metal was flat or trending lower in price.

The price of gold can provide valuable insights at times, but other times, it gives false signals warped by irrational market behaviors. We think the metal currently is getting caught up in a speculative bubble; in other words, its price is not presenting us with a meaningful warnings about fiscal, monetary, or geopolitical crisis.

In our view, gold is likely to have a more reliable and sustainable run higher when the Fed returns to its careless ways, with real yields near 0%, or even negative, and QE once again is in operation.

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Read more articles by Michael Lebowitz