09 Apr, 2024

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Gold has soared and hit one record after another this year, with the bulk of the bullish move taking place over the course of the past two months. During this upswing, the typical negative relationship between XAU/ USD and U.S. real rates (using the U.S. 10-year TIPS as a proxy) has broken down dramatically, unnerving investors.

As the chart below illustrates, bullion has climbed even as real yields (displayed on an inverted scale for better visualization) have risen relentlessly. This unexpected dynamic runs counter to the norm – higher bond yields typically dampen the appeal of non-interest-bearing assets like the yellow metal, as investors seek better returns in the fixed-income space.

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WHAT COULD EXPLAIN CURRENT MARKET DYNAMICS?

1. The Trend-Following Trap: Gold’s meteoric rise could signify a market fueled more by momentum than fundamentals. In this context, speculative fervor may be boosting prices , creating something of a bubble. If this proves true, a sharp correction – a swift return to historical averages – could be imminent as investors re-assess the yellow metal’s long-term value.
2. Financial Armageddon: Bullion’s strong rally might reflect the growing fear of a “hard landing” scenario by some market participants, where the aggressive tightening cycle of 2022-2023 triggers a recession and broader market turmoil. Gold, a traditional safe-haven asset, offers protection in the face of potential chaos and a way to protect wealth should a crisis materialize.
3. Inflation comeback on rate cuts: Gold bugs may be making a long-term play, speculating that the Fed will cut rates no matter what as a sort of insurance policy for the economy to prevent anything from going wrong in an election year. Easing monetary policy while inflation remains above target risks triggering a new inflationary wave that would ultimately benefit gold.

PERSONAL VIEW

I am inclined to believe in the first hypothesis. The annals of history are replete with instances where popular assets have fallen prey to speculative appetite, propelling prices to unsustainable heights divorced from underlying economic fundamentals. This unsustainable momentum creates a distorted environment where valuations lose touch with intrinsic value. Eventually, sentiment shifts, and a sharp correction follows, restoring a more realistic market equilibrium. I think this could happen to gold over the medium term.

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