In the past few months, demand for gold has been falling amid rising optimism over the vaccination campaign and the reopening of the economy. However, two major drivers are still pricing in further upside gains in the near to medium term.
First, we saw that as inflation expectations have been rising sharply in the past few months, US real yields have continued to reach new lows and are currently pricing in higher gold prices in the short run. Figure 1 shows that the 5Y US real interest rate have co-moved strongly with gold prices in the past cycle; the 5Y real rate is currently trading at -1.81% and is pricing in a ounce of gold above the $2,000 level.
The second driver is the total amount of negative-yielding debt in the market, which could also be seen as an indicator of market stress. Interestingly, figure 2 shows that gold prices seem to have followed the recent decrease in the amount of debt yielding below 0 percent; after remaining to an all-time high above 18tr USD in the beginning of the year, the total amount of negative-yielding debt has recently decreased to 16tr USD.
However, the most important driver of gold in the medium term remains the annual change in global liquidity, which we compute as total assets of the 5 major central banks (Fed, ECB, BoJ, PBoC and BoE). Figure 3 shows that gold prices have co-moved strongly with the annual change in global liquidity in the past cycle; hence, when the market realizes that social distancing norms and travel restrictions are going to remain elevated longer than participants currently expect, gold prices should experience another significant rally.