After a near-six-month hiatus, the gold price has suddenly surged again. That’s probably not an encouraging sign of things to come.
The price peaked, at record levels, above $US5300 ($7500) an ounce just ahead of the start of the war in the Middle East at the end of February. It then steadily reversed course, falling below $US4000 an ounce last month, before surging again to trade above $4400 an ounce this week. In just over a week it has climbed more than 8 per cent.
There were obvious catalysts for the movements in both directions.
The United States and Israel’s attack on Iran, which sent oil prices soaring and raised expectations of inflation, punctured gold’s record run.
The US Federal Reserve Board’s decision to leave its policy rate unchanged at last month’s meeting, and the inability of its new chair Kevin Warsh to dispel concerns that he will do Donald Trump’s bidding, has been a significant influence over the metal’s recent resurgence.
Last year’s gold rush was ignited by a speech given by Warsh’s predecessor, Jerome Powell, at the annual economic talkfest at Jackson Hole in Wyoming, where he signalled the start of an interest rate easing cycle that the Fed followed up with three rate cuts.
If investors fear that America’s finances might corrupt its monetary policies, the gold market looks like the obvious – perhaps the only – place to shelter.
The Fed seemed to be shifting its focus from inflation to protecting growth. Gold’s key appeal is that it provides a hedge against inflation, so that apparent shift in priorities set its market alight.
There’s an inverse relationship between the gold price and interest rates. Lower rates – because gold generates no income but has holding and opportunity costs – are positive for the price.
The price has been aided by last week’s weak US jobs data, which blunted the market’s expectations of a September rate rise, although inflation data this week could complicate assessments of the state of the world’s largest economy.
Weakening economic growth and sustained high, or rising, levels of inflation – stagflation – are, however, positive for gold, so even if the inflation rate remains elevated, it’s not necessarily threatening to the price. In those circumstances, gold’s “safe haven” status and its inverse correlation with inflation tend to support the price.
The Fed’s rate actions last year sparked discussion about the “debasement trade” and “fiscal dominance”, or the fear that government debt and debt-servicing costs were so out of control that central banks have to inflate their way out of the fiscal noose. For investors, that means a dash for safe assets, gold in particular.
The US has a debt issue, with gross federal government debt soon to hit $US40 trillion, or 124 per cent of GDP.
In the second Trump administration, nearly $US4 trillion will have been added in just over 18 months, with the country’s debt-to-GDP ratio blowing out from 5.8 per cent to about 6.5 per cent of GDP this financial year, according to the Congressional Budget Office’s latest projections.
The government’s net interest bill is nearing $US1 trillion, which is bigger than the Defence Department’s budget (or has been, before the “War Department” asked for $US1.5 trillion of funding next financial year).
The US isn’t alone with its debt mountain. In the post-COVID era, most Western governments have balance sheets that are stretched to unsustainable levels. But it is the epicentre of the world’s financial system and its Treasury securities are the alternative safe haven to gold for investors.
If investors fear that America’s finances might corrupt its monetary policies, the gold market looks like the obvious – perhaps the only – place to shelter.
The gold price over the past year has clearly been driven by a number of different factors, even if US inflation and interest rates might provide the most significant macro backdrop.
Trump’s trade wars, which also affect inflation and generate geopolitical instability, and his actual war in the Middle East, with its impact on oil prices (and subsequently inflation), have also driven ebbs and flows in the gold price as their fortunes have fluctuated.
Trump’s tariffs have been a moving feast as he’s imposed, withdrawn and threatened duties, and then been forced to change their legal basis entirely after they’ve been ruled illegal in the courts.
Similarly, the war in the Middle East has been on the verge of ending dozens of times, according to Trump, but the conflict continues.
That’s caused some volatility in the gold price, but the impacts have been quite clear.
When investors thought the Fed was likely to raise US rates to head off higher tariff and oil-driven increases in inflation, the gold price trended down. Very recently, when it looked like there might be a deal to end the war and the likelihood of the Fed raising rates receded, they sparked up again.
While this year has produced a volatile run for the gold price, there’s an underlying, longer-term trend towards high prices.
That started in 2022, when Russia invaded Ukraine and the G7 economies froze Russia’s foreign exchange reserves held offshore, weaponising the US dollar’s dominance of the financial system.
Since that moment, central banks have doubled their purchases of gold, which has now overtaken US Treasury securities as their biggest reserve asset.
“De-dollarisation” is real, particularly for China, which has been in the market for gold each and every month, without fail, for nearly two years.
The potential vulnerability shown by what happened to Russia’s offshore reserves is the obvious explanation for the explosion of central bank interest in gold, with an aversion to Trump’s aggressive “America First” policies, aimed at traditional friends and foes alike, providing extra motivation, if needed.
While there are some current and legacy issues to help explain the gold price’s movements in recent years, there are also some prospective threats to stability that will shape its future.
The Bank of Japan and US Treasury’s intervention in currency markets to defend the yen this month has highlighted the fragility of the financial system, for which Japan has been a source of vast, near-costless, funding for decades.
If the “carry trades” (using cheap Japanese funding to buy higher-yielding assets elsewhere) that have flourished over nearly 30 years were to suddenly unwind, and/or Japanese investors and Japan’s government were to repatriate the trillions of dollars in US treasuries, equities and other assets they hold, it would ignite another global financial crisis, with the US again at its centre.
There’s also mounting concern about the valuations, the rapidly increasing reliance on increasingly complex debt structures and the absence of cash flows that characterise the artificial intelligence boom and the infrastructure being built for it.
AI has become central to the US market and economy. The leverage associated with it has grown rapidly and is very substantial.
Yet the rate of investment in AI outstrips the cash being generated from it. It’s an implosion waiting to happen, unless the AI companies can dramatically boost their cash generation.
That’s a tricky backdrop for Warsh when he makes his first appearance at Jackson Hole late this month. If he fails to convince markets that he is committed to driving the US inflation rate down, the smiles on the faces of gold bugs might get even broader.
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