Lower real yields to support a higher gold price - Capital Economics
Metals

Lower real yields to support a higher gold price

Precious Metals Update
Written by James O'Rourke

We have raised our forecast for the gold price, as we expect real yields to drift a little lower and remain low for some time. We now think that the price of gold will finish the year at $1,900 per ounce ($1,600 previously) and will remain elevated over the next couple of years.

  • We have raised our forecast for the gold price, as we expect real yields to drift a little lower and remain low for some time. We now think that the price of gold will finish the year at $1,900 per ounce ($1,600 previously) and will remain elevated over the next couple of years.
  • The gold price has risen by nearly 20% this year, as real yields (measured in Chart 1 by the 10-Year US Treasury Inflation Protected Securities (TIPS) yield), have fallen. As a recap, the lower the real yields of US government bonds, the lower the opportunity cost of holding competing assets such as gold. This year, most of the decline in real yields initially came from a plunge in nominal interest rate expectations, but in recent months a rise in inflation breakevens has played a central role. (See Chart 2.) For reference, inflation breakevens in this instance are the difference between the nominal Treasury yield and that of the real (TIPS) yield, or in other words, a market-based measure of inflation expectations.
  • In the near term, we reckon that inflation breakevens will drift higher, back to pre-pandemic levels, as economies recover from their lockdown-induced slumps. And although we expect nominal 10-year Treasury yields to inch up too, they will not rise by as much. The net effect of these moves will be to drag real yields lower by end-2020. (See our Asset Allocation Update.) As a result, we expect the gold price to push a little higher by year-end. This view is supported by our forecast that the US dollar will weaken in the second half of 2020.
  • Longer term, we expect real yields to remain low, as we think that interest rates will stay at current levels, whilst 10-year Treasury yields will be firmly anchored by loose monetary policy. These factors will keep the price of gold elevated over the next couple of years. Admittedly, as economic uncertainty fades, demand for safe-haven assets including gold should fall. However, this is only likely to take a little shine off the gold price, as ultra-low real yields remain a key support.
  • What’s more, although they aren’t being reflected by market-based measures of inflation, we think there could be clusters of investors – concerned about the potential for runaway inflation owing to ultra-loose monetary policy – who will seek refuge in the gold market. Yet we are firmly of the view that these inflation fears will prove unfounded. In the near term, weak demand should hold back the inflationary effects of supply constraints and policy stimulus. And in the medium term, we think that firms are more likely to shore up their balance sheets than embark on an inflationary spending spree. (See our Global Inflation Watch.) As such, demand for inflation hedges should fade.
  • In sum, we have become more positive on the outlook for the gold price. And even if some of the steam comes out of the gold price rally next year, the backdrop will remain supportive, limiting any downside.

Chart 1: Gold Price & 10-Year US TIPS Yield

Chart 2: US Treasury Yields & Inflation Breakevens (%)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


James O’Rourke, Commodities Economist, +44 20 3927 9834, james.orourke@capitaleconomics.com