In general, three main factors affect the price of gold in the long run: (1) the dollar, (2) the U.S. level of inflation and (3) monetary policy in the United States.
The gold price stably negatively correlates with the Dollar Index. And it is actually normal because gold is dollar-denominated:
But at the same time, one needs to understand the difference: the Dollar Index by itself does not affect the gold price, it affects its dynamics. And judging by the history, when the Dollar Index equals, for example, 80, the gold price may be $900, $1400, or even $1700:
Therefore, the dollar does not play a significant role in determining the fundamentally balanced price of gold.
The U.S. real interest rate
By and large, there is one main indicator that greatly affects the price of gold – this is the U.S. real interest rate. I want to remind you that the real interest rate is the nominal interest rate (or, in my case, the 10-year Treasury yield) minus the inflation rate.
And now we will do the following. Based on the history of the last 13 years, let’s build a model that will predict the price of gold based on the U.S. real interest rate level.
It turns out that the quality of such a model is really high: R2 = 0.77 and p-value <0.05:
Here is the model itself:
So, this leads us to a simple conclusion: to predict what will happen to the price of gold, we must understand where the real interest rate is going.
Generally speaking, looking back over the past 700 years, it should be noted that the average global real rate has a long-term downward trend:
The main reason for this is the steady decline in global nominal bond yields:
Here, it should be noted that many developed countries already live in conditions of negative rates:
And in this context, the situation in the U.S. is an exception rather than a normal state of affairs:
Even President Donald Trump has said he would like to try negative rates in the U.S.:
It is also very important to remember that the total market capitalization of the S&P 500 relative to the U.S. nominal GDP is close to the historical maximum. And in such an unstable state, one can hardly even talk about raising rates.
In early February, the U.S. real rate broke through the zero point and entered the zone of negative values. And in my opinion, this is just the beginning. In turn, this indicates that gold will only go up in price in the long run.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.