There is no doubt: gold prices exceeded our expectations in Q1’22. Our rationale for not taking a bullish outlook on gold was, and still is, well-founded: Central banks, including the Federal Reserve, began to scale back pandemic-era stimulus efforts, bullish cycles rates just beginning.

At least in the short term, a powerful catalyst has arrived that has exceeded expectations of interest: Russia’s invasion of Ukraine. With global financial markets in turmoil and commodity supply chains in disarray, inflation expectations have soared again. Instead of a rise in real yields, we saw a decline in real yields from mid-February to the end of March.

Alas, with the prospect of a Russian-Ukrainian ceasefire gaining momentum towards the end of the first quarter of 22, it is possible that the sanctions against Russia will be lifted, thus removing the pressure on the chains of global supply of raw materials. In turn, inflation expectations could recede and, in line with the longer-term narrative of central banks raising interest rates, real yields could begin to rise again.

Therein lies the challenge for gold prices in Q2’22: unless there is a dramatic escalation in the conflict between Russia and Ukraine that locks in the European Union and the states United in a protracted dispute, the catalyst that has driven gold prices higher in recent months is likely to be short-lived.

U.S. Real Yields Prove Problematic

Despite the disruption created by the Russian invasion of Ukraine, the same hurdles now remain for gold prices. As central banks strive to reduce realized inflation, which is consistently higher in the near term, longer-term inflation expectations should begin to ease, pushing down real yields and preventing prices from rising. gold to hold on to recent gains.

Gold, like other precious metals, has no dividend, yield or coupon, so rising US real yields remain problematic. In other words, when other assets offer better risk-adjusted returns or, more importantly, offer tangible cash flow at a time of raging inflationary pressures, assets that do not produce meaningful returns fall. often in disgrace. Gold behaves, in effect, as a long-duration asset (as measured by modified duration, not Macaulay duration); a zero coupon bond.

Gold futures versus US Treasury nominal (Chart 1)

Source: Bloomberg

The facts on the ground have not changed and will have greater influence if Russia’s invasion of Ukraine ceases. Monetary easing enacted by central banks and fiscal stimulus provided by governments are now firmly in the rearview mirror. A ceasefire between Russia and Ukraine will relieve pressure on food and energy prices, which will help lower inflation expectations. But due to the high level of inflation in economies like the EU, US and UK, central banks will continue to aggressively raise interest rates during 2022.

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Source: Bloomberg

It therefore goes without saying that the rise in real rates constitutes a significant obstacle for gold prices over the next few months. Over the past five years, gains in US real yields have generally been correlated with losses in gold prices. A simple linear regression of the relationship between the weekly change in gold prices and the weekly basis point change in the US 10-year real yield reveals a correlation of -0.34. Generally, rising real yields are bad for gold prices.

With the exception of World War III, it is hard to imagine how the environment becomes more attractive for gold prices from a fundamental perspective. Yes, there are talks about how EU and US sanctions on Russia are threatening US dollar hegemony, which could ultimately prompt more countries to abandon dollar-denominated reserves and allocate more reserves to gold. But that’s a longer-term story, one that won’t play out over the next quarter, or even the year, especially as over 40% of global trade continues to be denominated in USD (and 35% in EUR).

In short, gold prices have two likely trajectories: sideways (as the Russian invasion of Ukraine continues, continued high inflation expectations as central banks raise rates, continued actual returns); or lower (at the end of the Russian invasion of Ukraine, driving down inflation expectations as central banks raise rates, pushing real yields higher).

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