Some factors derived from the current conflict between Russia and Ukraine, as well as the fact that the Fed’s action lags behind inflation, are decoupling the gold price from the US real interest rate.

Gold is highly sensitive to the rise of us real interest rate, which increases the opportunity cost of holding gold due to the “zero coupon” of gold.

From historical experience, there is a nearly perfect negative correlation between the real interest rate of US bonds and the price of gold.

However, this relationship has been broken since early March: the 10-year real interest rate of US bonds has risen from - 0.70% in mid March to close to 0 at present, which is not a small increase. However, the price of gold has not decreased, but increased to a certain extent - it seems that it is not worried about the radical measures of the Federal Reserve.

Why did gold ignore the rise in real interest rates?

Zhang Zhipeng, Xue Jun and Jiang Chenlong, analysts of Orient Securities, said in their report on April 14:

Since February this year, the geopolitical crisis, the Fed’s interest rate hike and other multiple macro events have superimposed, making gold face a more complex political and economic environment than ever before. The risk aversion, “de dollarization” and inflation expectations derived from these macro factors have affected the gold price in different directions, It also makes the gold price trend deviate from the traditional real interest rate pricing framework of US bonds to a certain extent.

How to understand the driving logic of the current gold price and how to deduce the future price? Orient Securities has made some analysis and discussion from different dimensions.

Gold analysis framework

As a background supplement, we can first understand the analytical framework of gold price.

In fact, there are many factors that affect the price of gold, and analysts have established analytical frameworks from different angles. For example, economist Ren Zeping divided the factors affecting the price of gold into six aspects from the monetary, financial and commodity attributes of gold, namely, the dollar index, risk events, real interest rate, inflation level, gold supply and gold demand, and the actual driving factors behind these six factors, It is mainly closely related to changes in the US economy, real interest rates and the central bank’s buying / selling behavior.

He also constructed a research framework for analyzing long-term and short-term gold prices according to importance and long-term and short-term indicators:

From the above research framework, it can also be seen that the impact of US bond real interest rate on gold price can not be ignored.

However, some factors derived from the current conflict between Russia and Ukraine, as well as the fact that the Fed’s action lags behind inflation, are decoupling the gold price from the US real interest rate.

The “hedging effect” of Russian and Ukrainian demand

Since the outbreak of the conflict between Russia and Ukraine, driven by risk aversion, the price of gold has risen rapidly, once hitting a record high of US $2055 / ounce on March 8. Since then, the high price of gold has fallen back due to the retreat of risk aversion, but it remains at a high level.

As one of the most serious geopolitical crises since the end of the cold war, the conflict between Russia and Ukraine may still have an impact on gold prices in the medium and long-term time dimension.

The first is to intensify the central banks of various countries, especially the central banks of emerging economies, and accelerate the process of “de dollarization”.

The unprecedented unlimited leniency policy of the Federal Reserve during the epidemic in the previous two years has exacerbated global concerns about the dollar based monetary system.

After the outbreak of the conflict between Russia and Ukraine, the United States and other western countries launched economic, financial and trade sanctions against Russia. In particular, major Russian banks are prohibited from using the swift system, imposing sanctions on the Russian central bank, freezing foreign exchange reserves and confiscating overseas assets.

To some extent, these sanctions undermine the security of one of the world’s most important security assets (US Treasury bonds). Especially for countries that hold large foreign exchange reserve assets but are not allies of the United States, this means that it will no longer be safe to invest in US Treasury bonds in the future.

As a result, many investors or institutions engaged in global asset allocation have reduced their non home country sovereign risk exposure and returned their domestic assets. At the same time, more importantly, if the status of US Treasury bonds as one of the safest assets in the world is damaged, the credit of the US dollar in the international monetary system will also be weakened.

Gold naturally has the attribute of dollar hedging. In seeking safe assets, especially in the current narrative of “de dollarization”, the position of gold in asset allocation may be further highlighted.

The conflict between Russia and Ukraine has strengthened inflation expectations

Secondly, the conflict between Russia and Ukraine triggered a surge in the prices of crude oil, basic metals, agricultural products and other commodities, strengthening global inflation expectations.

In March, the inflation indicators of developed economies such as Britain and the United States continued to soar, among which the prices of energy and food increased even more.

The inflation expectation implied in US bonds characterized by “US 10-year Treasury bond yield real yield” has increased from about 2.50% to 2.87% (up to 2.95%) after the Russian Ukrainian conflict.

When inflation rises more than nominal interest rates, it will push down real interest rates. Therefore, the strengthening of inflation expectations also strengthened the price of gold.

The Fed is moving too slowly

Thirdly, although the Federal Reserve released the signal of partial eagle and the yield of 10-year Treasury bonds also showed a very significant upward trend, the gold price did not show weakness. After falling on the day of interest rate hike in March, it recovered its lost ground immediately. Up to now, the price has risen to a certain extent compared with the day of interest rate hike.

Orient Securities pointed out that the reason behind it is that, in addition to the “de dollarization” caused by the Russian Ukrainian conflict mentioned above, the purpose of the Fed’s interest rate increase is to curb inflation. If the Fed’s interest rate increase lags behind the inflation curve, the response of gold price to the rise of nominal interest rate is relatively passive.

This can also be verified by historical experience, such as the interest rate increase cycle from June 2004 to September 2007 (gold price trend is very strong) and the interest rate increase cycle from December 2015 to December 2018 (gold price fluctuates widely).

Wall Street has previously mentioned that according to the Taylor rule, the current theoretical benchmark interest rate in the United States is 4%, and the actual benchmark interest rate is at least 165bp behind. The Federal Reserve is far behind the inflation and inflation curve.

On the other hand, despite the withdrawal of liquidity, the Fed’s $9 trillion balance sheet and even risky assets do not feel the fear of reduction (liquidity crisis), which also explains why gold prices continue to explore upward space despite the rise of real interest rates (still negative).

In fact, the Finnish Analysis Agency Voima gold precious metals analysis