November 01, 2023
Gold has reached an important level. In late October, as the conflict in Gaza unfolded, it broke through $2,000 per ounce.
Stock markets haven’t done nearly as well. Over the past 12 months, the S&P 500 index is up 7.6%. Gold is up 22.2%.
This performance flies in the face of conventional wisdom.
After all, shouldn’t gold be struggling with high interest rates?
(If interest rates go up, gold’s performance usually suffers.)
It’s not the case this time.
Let’s see what caused this performance and what could be coming next.
When the Federal Reserve and other central banks started hiking interest rates, the price of gold took a hit.
It dropped from its 2022 high of about $2,043 to a low of $1,623 in September.
The conventional wisdom of “gold doesn’t pay interest” prevailed for a short period of time as investors adjusted their holdings. Bonds and money market funds became quite attractive due to rising interest rates.
Not anymore, however.
Bonds have delivered a terrible performance recently. (More on this later.)
Over the past 12 months, the iShares Core U.S. Aggregate Bond ETF (AGG) is down about 2.7%.
And, as a reminder, gold soared by 22.2% over the same period.
Investors were slow to realize that bonds may not be as safe as they seem. So, a gold rally began.
From its September low of $1,623 to the late-October high of $2,005.60, gold has appreciated by over 24%.
Bonds lost 3.7% since then.
However you look at it, bonds aren’t as reliable as they were in the past.
And it’s getting worse.
Interest rates are high because central banks decided to lift them pretty much across the world.
But central banks aren’t the only actors in the markets.
Investors can influence the prices of bonds by buying or selling them.
And sell them they did…
Since the beginning of the year, long-term debt has become more expensive… and the Fed has nothing to do with it.
Yields on long-term bonds have soared by about 1.5 percentage points since the beginning of the year.
To put this in perspective, this amounts to six 0.25-percentage-point (or 25-basis-point) hikes.
And the year isn’t over. Neither is the bond selloff.
Interest rates are up because bond prices are down. The more investors sell bonds, the higher interest rates go.
So right now, they are doing what the Financial Times calls “Fed’s work.”
Which isn’t helping mainstream investors… but it has been supporting the price of gold.
In our opinion, the bond market rout will continue.
Not because interest rates are going up (they don’t have to) but because investors have other reasons to sell debt and buy the ultimate safe haven—gold.
First, there’s the war in the Mediterranean. Nobody knows how long and how bad it will be. So, the market assumes the worst, as it often does.
And the worst scenario is a regional conflict that will plunge multiple countries into a state of crisis and cause widespread tensions across the world.
Commodities markets could be impacted. As a result of the conflict, the price of oil could reach as high as $150 per barrel, says the World Bank.
Higher oil prices would drive inflation… and propel gold even higher.
Second, the ongoing bond market rout made long-term loans expensive… including government loans.
Now, there’s a possibility that high interest rates will turn against the U.S. government and cause even more problems for one of the world’s largest lenders.
Nobody can say exactly what the impact will be. But the direction is clear: debt has become even more expensive than the Fed anticipated, and markets are worried.
This anxiety launches a series of “aftershocks,” one of which is a higher degree of distrust in the mainstream financial system.
As a result, alternative assets and safe havens such as gold have a really good chance of advancing further.
The slightest hint of a potential recession would only strengthen the thesis that gold is the number one asset during times of war, shocks, and volatility.
There are multiple catalysts driving the price of gold. Some of the most important ones are aligned to continue pushing the price of the yellow metal upward.
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