Gold prices have recently plummeted to their lowest levels since March, facing headwinds from the persistent strength of the U.S. dollar and 10-year bond yields inching closer to the 5% mark. The yellow metal breached crucial support at $1,900 in September, signaling a bearish trend. During China’s “Golden Week,” Western bullion banks were actively covering short positions, contributing to a waterfall decline in Gold Futures towards its rising 200-week moving average at $1,820.
Despite these short-term challenges, taking a step back to assess the broader macroeconomic landscape suggests that the stars may be aligning for gold once again. Rising energy prices, combined with slower economic growth, are giving rise to a stagflationary environment. This, in turn, is expected to propel Gold Futures back above the $2,000-an-ounce mark.
As we enter the final quarter of 2023, the list of known risk factors is expanding, fueled by a relentless sell-off in government bonds, which has driven global treasury yields to levels not seen since the pre-Global Financial Crisis era in 2008. Government borrowing costs influence a wide range of financial factors, from mortgage rates for homeowners to loan rates for companies.
The mounting debt and geopolitical instability could potentially deter foreign investors from finding U.S. bonds appealing, raising the risk that the Federal Reserve loses control of yields and is compelled to step in as a last-resort buyer. If yields continue to rise, the Fed might resort to new quantitative easing measures before considering rate cuts, particularly in light of the Fed’s public acknowledgement that the elusive 2% inflation target may never be attained – a development that could bolster gold prices.
The rapid and steep decline in bond prices has sent shockwaves through the stock market, causing major equity indexes to erase their year-to-date gains. The S&P 500, for instance, has not only erased all its 2023 gains but also entered correction territory. Some market analysts draw parallels between the strong 2023 stock market rally and the run-up to the 1987 crash, which saw the S&P 500 rally about 39%, peak in August, and then crash in October, wiping out all its gains in just two weeks.
Notably, the current rally, which began in October 2022, surged approximately 31% by July before showing signs of a potential downward spiral. If the S&P 500 closes below critical support at 4,200, the likelihood of a significant decline during this precarious period would increase substantially.
Gold has demonstrated remarkable resilience in the face of surging bond yields. A year ago, when the 10-year bond rate was around 2.5%, gold was trading at roughly $1,820. Despite nearly doubling to 4.8%, gold continues to trade around the $1,820 mark, mainly attributed to Eastern central banks consistently adding to their bullion reserves.
Recent data from the World Gold Council indicates that central banks acquired 77 tonnes of gold in August, marking a 38% increase compared to July. Over the past three months, central banks have collectively purchased 219 tonnes of gold, following record-breaking purchases in the first half of the year.
These persistent acquisitions underscore that central banks’ appetite for gold is far from satiated. The unwavering strength of the U.S. dollar has amplified the financial burdens faced by nations with U.S. dollar-denominated debts, making diversification away from the dollar an attractive proposition. Gold remains the most appealing global monetary asset in this context.
As 10-year bond yields inch closer to the 5% threshold, Western investors may begin to recognize the mounting debt risks in the United States. With growing recession concerns, investment demand for gold is poised to rebound.
Economists have expressed concerns over the Federal Reserve’s rate hikes, with many believing that the central bank may have gone too far. Another rate hike in the upcoming month is increasingly likely, potentially setting the stage for another policy misstep by the Fed, which initially downplayed the notion of persistent inflation as “transitory” for an extended period before embarking on rate hikes in March 2022.
The Federal Reserve’s delayed response to inflation has left it in a challenging position, with rates rising at the fastest pace in over four decades while the government eliminated the debt ceiling. The further the central bank ventures into restrictive territory, the greater the likelihood of encountering unforeseen events – reminiscent of the recent failures of the second, third, and fourth-largest banks in U.S. history.
Should the Fed aggressively raise rates, pushing the 10-year bond yield above 5%, the risks of financial system disruptions intensify. A parallel scenario involves the central bank maintaining its current stance, which could signal the end of the tightening cycle – a scenario that would favor gold.
This week’s U.S. ADP report revealed the twelfth consecutive weekly decline in wages for a population burdened with debt. Consequently, heightened volatility and uncertainty are expected to persist in the U.S. dollar as the country grapples with escalating government debt, soaring consumer credit card balances, and ballooning personal interest payments.
U.S. credit card balances have surpassed $1 trillion, while interest rates on credit cards have soared to over 22%, exacerbating the plight of debt-laden consumers and driving an increase in delinquencies. The United States is grappling with a mounting debt load of nearly $33.5 trillion, coupled with a projected $2 trillion increase in the deficit for the year.
This burgeoning government debt is poised to have multiple economic ramifications, including sluggish growth, as government resources are increasingly channeled into public spending. Monetary implications could manifest as the Federal Reserve is increasingly called upon to support government financing.
Historically, gold has thrived during periods of eroding confidence in Federal Reserve policy and government actions. The looming threat of a U.S. government shutdown remains a potential catalyst for gold, even as the current crisis has been temporarily postponed for 45 days.
As a split Congress grapples with government funding, U.S. bond markets are pricing in the most expensive Treasury borrowing costs in 16 years. Simultaneously, there is growing scrutiny of the long-term trajectory of interest rates and fiscal policy. Moody’s has issued a warning that public financing dysfunction and potential disruptions in debt servicing could jeopardize the last remaining AAA credit rating among the three main rating agencies.
Furthermore, the U.S. House of Representatives has experienced unprecedented turmoil, resulting in uncertainty and a contentious battle over the speaker position. Until a new speaker is appointed, progress on government funding bills is expected to be stalled, heightening the risk of a partial government shutdown by the November 17 deadline.
These challenges coincide with increasing concerns over government debt and the potential impact of an over-extended Federal Reserve.
