The performance of gold prices in the context of changes in real interest rates has not been all that surprising. Since the start of the year, longer-dated real interest rates, as denoted by 10 year TIPS in this chart, have been falling. All other thing being equal, this should boost the gold price.
But at the same time, the US dollar strengthening substantially over the past 12 or so months. While the US dollar has weakened more recently, it is still 8.5% stronger than the start of 2015 on a broad trade weighted basis.
The recent gold price performance in this context is more interesting, with gold consistently resisting the strength in the dollar.
We have been running a simple regression model of gold versus the broad TWI and 10 year TIPS since the start of 2009. While it hasn't been perfect, it shows that the relationship between gold prices and these other key variables was very consistent up until early 2015.
The implication is that the common factors driving real interest rates and FX accounted for the vast majority of the movement in gold prices in a very consistent way from 2009-2014.
But this has shifted markedly over the past 6 months in particular, with the model significantly underestimating the gold price given the current level of the US dollar and real interest rates.
We have written about these types of shifts on this blog before here and here. The chart to the left highlights the most recent paradigm shift that occurred in 2008 around the financial crisis. The model that worked consistently from 2000-2008 became irrelevant to the performance of gold relative to bonds and FX markets following the flight to safety during the financial crisis.
Gold price positive paradigm shift?
In previous paradigm shifts of gold price behaviour, there was a big change in the macro-financial landscape and outlook. In 2008 it was the financial crisis. In the early 2000's it was the ramp up in global liquidity. In the 1990s it was the decline in inflation and interest rates following the 1980s.
This time around, this shift could be due to the divergence in central bank policy and the impact on global capital flows. The probability of a Fed hike in the foreseeable future increased markedly in early 2015, while other central banks continue to wheel out more unconventional policy. This divergence has had a huge impact on FX markets and capital flows into emerging markets. But it hasn't had as much of an impact on longer-dated real interest rates given US and global growth is not particularly vibrant.
This change in gold behaviour relative to the US dollar means that it is now much more leveraged to movements in real interest rates. This has been price positive in the last 12 or so months, but it could mean that the gold price could fall sharply if real interest rates start to rise quickly. This has been the forecast of many economists for quite a while, but has so far proven to be much more elusive than most have anticipated.
