The surge in gold prices in not good news: an explainer on what's driving it
AdamSummary:
Gold’s surge reflects Fed dovishness, falling real yields, and rising inflation risks—conditions usually bullish for bullion. But it signals policy mistakes, stagflation fears, and threats to Fed independence, raising systemic uncertainty.
Gold is of course one of the main topics of the day in the markets as the precious metal is approaching the all-time high after several months of rangebound price action. Now, this latest move higher since Friday could be just a technical squeeze and I wouldn't chase it ahead of the key US data. Nonetheless, it's a good opportunity to talk about the reasons driving it higher.
The catalyst that triggered the whole rally that eventually led to a breakout of the 4-month range was of course Powell's dovish tilt at the Jackson Hole Symposium.
Federal Reserve Bias and Real Yields
And this is the first bad news for the surge in prices. A too accomodative Federal Reserve into a strengthening economy and rising inflation.
The main driver of gold prices is the change in real yields. In this case, the real yield is the difference between nominal Treasury yield and inflation expectations.
When inflation expectations rise faster than nominal yields or nominal yields fall faster than inflation expectations, real yields fall and that’s positive for gold. Conversely, when inflation expectations fall faster than nominal yields or nominal yields rise faster than inflation expectations, real yields rise and that’s negative for gold.
In the chart above you can see that when the Fed started to hike rates in 2022 and kept the tightening bias, gold prices kept on falling for most of the year. By the end of 2022, we reached the peak in the tightening expectations and the market started to look towards a less hawkish Fed after the first lower than expected US inflation report.
That unwinding led to the first rally that extended into the summer of 2023 where hawkish data and Fed commentary led to a correction into the final part of the year. Then again, Fed's Waller was the first governor opening the door for rate cuts and eventually the Fed adopted an easing bias.
Since then, gold just kept on rallying and the momentum increased when the market priced in more and more rate cuts. Of course, when we got the hawkish repricing in those aggressive cuts, we saw pullbacks like the one in November 2024 when Trump got elected and the markets expected a less dovish Fed.
The problem is that Trump adopted policies that the markets expected to be stagflationary. The trade war and the tax cuts led the market to expect higher inflation with lower growth. That culminated in the "Liberation Day" when Trump unveiled much aggressive tariff rates than expected. Gold experienced a parabolic surge.
Luckily, Trump reversed his aggressive tariffs and the de-escalation led to improving economic conditions. The Fed got less dovish because of the inflation threat and gold of course got stuck in a range awaiting the next direction.
Now, the economic conditions are clearly improving. The tariffs saga is behind us, even though there are still minor things going on. The data is showing a strengthening economy as seen also with the latest US PMIs and Atlanta Fed GDPNow. Inflation risk is much higher than recession risk. And in the face of this, the Fed wants to cut interest rates.
In fact, real yields have been falling recently and that was a tailwind for gold prices. The Fed's dovish reaction function is what continues to support gold. And that's not going to change unless they start talking about rate hikes (which looks like it's not going to happen anytime soon).
The Fed might be making another policy mistake which not only could keep inflation higher for longer, but could also lead to a de-anchoring of inflation expectations. And re-anchoring them would require a painful recession.
Attacks on Fed Independence
The second bad news is the continuous attack on Fed independence from the Trump's administration. Last week, US VP Vance made it pretty clear that they are against Fed independence in an interview with USA Today. Moreover, Trump is testing his powers of firing Fed governors with Fed governor Lisa Cook. This is all noise for now because Fed independence can be reduced or revoked only by the US Congress and it's very unlikely that it would ever happen.
Nonetheless, that's a risk (and a huge one) to keep an eye on because the economic and financial consequences would be enormous. In such a scenario, gold would be the best asset to own and we would almost certainly see a once in a lifetime parabolic surge in prices.
Source: investinglive
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