Under the traditional pricing framework, gold has the triple attributes of currency, commodity and finance, corresponding to currency, inflation resistance and safe-haven value, so it usually moves inversely with the US dollar and US Treasury interest rates. But recently, this pricing law has "failed", and gold, interest rates and the dollar have risen together. Is this seemingly "contradictory" divergence a new and more important pricing factor, or is it just an illusion of short-term emotional euphoria?
Since 1971, only 17.5%, 16.0% and 11.8% have strengthened monthly, quarterly and semi-annually, with two oil crises and Latin American debt crises being some examples. The U.S. economy tends to be more resilient than the rest of the world, making both U.S. dollar and U.S. Treasury interest rates stronger, and the demand for safe-haven and value preservation comes more from outside the United States. However, this scenario cannot be understood as a decline in the global credit of the dollar, otherwise the dollar should also weaken significantly. Even if there is, it is more likely that the demand for de-dollarization in local areas has affected the incentive to hold the dollar.
After the three rise together, the frequency of turning into a decline in the following month is more than half, and the previous gains are often given back within two months. Looking ahead, we believe that gold is overdrawn in the short term, but the interest rate cut trade is not over, and the pivot is at 2400~2500 US dollars / ounce; Whether or not we are undergoing a third global monetary system anchoring will have a significant impact on the pricing of assets, including gold.
Since the beginning of the year, gold has surged by more than 16%, making it one of the brightest assets in the world, behind Bitcoin (+52.3%). Gold is in the spotlight not only for its impressive gains, but also for a "challenge" to the traditional pricing framework: gold's usual inverse move against the US dollar and US Treasury real interest rates has "failed". Since April, the nominal interest rate of the 10-year U.S. Treasury bond has risen to nearly 4.7%, the real interest rate has risen from 1.87% to 2.41%, the dollar index has risen from 104 to 106, and gold has risen by more than 7% until recently. With this seemingly "contradictory" trend at work by new and more important pricing factors, or is it simply an illusion of short-term emotional euphoria? With this question in mind, we focus on the causes and consequences of this divergence in history in order to explore the implications for the present and future trends.
Chart 1: Global Asset Performance Matrix
Source: Bloomberg, CICC Research
Chart 2: Gold's Pattern of Typically Moving Opposite to the US Dollar and US Treasury Real Interest Rates Has "Failed".
Source: Bloomberg, CICC Research
Why are gold, interest rates and the dollar rising together? Partial safe-haven and "de-dollarization" demand, but strong growth in the United States
Since the disintegration of the Bretton Woods system, the global monetary system has shifted from a fixed exchange rate system based on gold to a floating exchange rate system based on sovereign credit, and has gradually established a dollar-dominated global monetary system through the dollar cycle of "US trade deficit and foreign real investment to export US dollars, and overseas investment in US financial assets to return US dollars". Gold's combination of monetary, commodity, and financial attributes corresponds to currency, inflation, and safe-haven value, making its price movement usually opposite to the real interest rate of the US dollar and US Treasury bonds, and is also the traditional pricing framework. 1) From the perspective of monetary attributes, gold's natural monetary attributes are substituted or even mutually exclusive with the US dollar as a global reserve currency, so when the US dollar weakens due to the weak US economy, the US credit is damaged, or there is a local demand for de-dollarization, the "seesaw" effect between gold and the US dollar will be highlighted. 2) Gold's commodity properties make it inflation-resistant, so high inflation tends to push up the price of gold and lower real interest rates. 3) As a financial asset and a non-interest-bearing asset, the risk-free interest rate is the opportunity cost of holding gold, so when the borrowing cost is low, the return on holding other assets is low or even loss, the value of gold will also increase, reflecting its hedging function, which is inversely related to the risk-free interest rate. In addition, since interest rates are largely determined by the U.S. currency, growth, and inflation environment, and the U.S. dollar depends on the relative strength of the U.S. and other major economies, it is also a source of possible bias in the relationship between the three.
Chart 3: Gold moves inversely with interest rates and the U.S. dollar in most cases, with all three rising at the same time accounting for 17.5%
Note: The sample is from 1971 and the real interest rate before 1997 is estimated
Source: Bloomberg, Haver, CICC Research
Chart 4: Gold, interest rates vs. the U.S. dollar
Source: Bloomberg, CICC Research
Based on the above framework, the relationship between gold, interest rates and the US dollar can be divided as follows:
► Normal scenario: gold is strong, interest rates are falling, and the dollar is weak. This is most often the case, with 43.8% of the months in which gold has risen since 1971. This situation may correspond to the above three attributes, from the data, except for the period of 1976~1978, before Volcker's sharp interest rate hike, the U.S. economic growth rate exceeded the world, and most of the intensive periods of this situation were that the U.S. economic growth rate was weaker than the world. It is characterized by a weak U.S. economy, lower interest rates, lower exchange rates and stronger gold. For example, from 2000 to before the financial crisis, the U.S. interest rate pivot fell, emerging markets such as China grew faster than the U.S. economy, and the U.S. dollar depreciated.
Chart 5: Gold is strong, interest rates are falling, and the dollar is weak, and most of the intensive periods of this scenario are the US economy growing weaker than the world
Source: Bloomberg, Wind, CICC Research
► The U.S. dollar is inverse to interest rates: gold is strong, interest rates are rising, and the U.S. dollar is weak. This accounted for 21.1%, suggesting that while the recovery of the U.S. economy has pushed real interest rates higher, the growth momentum of other non-U.S. economies has been stronger, resulting in a weaker dollar and higher Treasury rates. This was the case in 2017, with real interest rates rising by 11.7bp between late 2016 and January 2018, the dollar index falling 12.8% and gold rising 17.2%. At that time, the Fed was in a cycle of raising interest rates and shrinking its balance sheet, and policy expectations such as Trump's tax cuts pushed interest rates higher, but the real economy had not yet significantly recovered. In contrast, China's growth has been stronger driven by the monetization of shantytown reform, achieving a "V-shaped repair" and driving the recovery of non-US economies. The renminbi and overseas funds rebounded strongly and flowed in even as the Fed continued to tighten at the time, with the renminbi strengthening and the dollar index falling, supporting gold's rally.
Chart 6: The U.S. Economic Recovery Drives Real Interest Rates Higher, but Other Non-U.S. Economies Have Stronger Growth Momentum, Weakening the U.S. Dollar and Keeping Treasury Rates Higher
Source: Bloomberg, CICC Research
► The U.S. dollar is inverse to gold: gold is strong, interest rates are falling, and the U.S. dollar is strong. This scenario accounts for 16.9%, reflecting a safe-haven portfolio, or a trade of interest rate cuts, but the U.S. economy is more resilient relative to the world. For example, in March 1973, Hong Kong stocks plummeted, the Hang Seng Index fell from 1,775 points in 1973 to a low of 150 points in 1994, and in the two months from March to April, the US real interest rate fell by 19.6bp, the US dollar index rose by 1.3%, and gold rose by 22.0%. In 2019, the economic pressure under the Sino-US trade friction has risen, the Federal Reserve has turned to interest rate cuts, promoting the recovery of the real estate cycle, China's economic recovery has been more modest, the overall "L" shaped repair, and the US dollar has strengthened. From the end of 2018 to August 2019, real interest rates fell by more than 100bp, with the US dollar up 2.9% and gold up 18.5%. This scenario accounted for 16.9%.
► The U.S. dollar is inverse to interest rates and gold: This scenario accounts for 17.5% and is currently experiencing, which tends to indicate that the U.S. economy is more resilient relative to the world, making the U.S. dollar and U.S. Treasury interest rates stronger, and the demand for safe-haven and hedging comes more from outside the United States.
However, this scenario cannot be understood as a decline in the global creditworthiness of the dollar, which would otherwise weaken significantly. Even if there is, it is more likely that the demand for de-dollarization in local areas has affected the incentive to hold the dollar. From the perspective of the holdings of central bank reserves in gold, the scale of gold reserves in most countries such as China, Japan and Germany has increased since 2022, but China has led the growth rate, with gold reserves increasing by 31.4% so far in 2022.
Chart 7: The share of gold reserves in most countries, including China, Japan and Germany, has been growing since 2022, with China leading the way
Source: Wind, CICC Research
Chart 8: Gold, real interest rates and the U.S. dollar have risen in tandem
Source: Bloomberg, CICC Research
Historically, what happened to gold, interest rates and the US dollar rose together? It is not common, and it is mostly a risk-off or even crisis environment, and it is not very persistent
Since 1971, it has been uncommon for gold to be strong, accompanied by real interest rates and the frequency of 11.8% on monthly, quarterly and semi-annual time frames of 17.5%, 16.0% and 11.8% respectively. Specifically, this situation occurred mainly in the global risk-off environment caused by unexpected events, such as the Fourth Middle East War and the First Oil Crisis in 1973, the Second Oil Crisis in 1979, the Latin American Debt Crisis in 1983[1], the Black Monday and Stock Market Crash in 1987, the October Incident in Russia in 1993[2], the Asian Financial Crisis in 1998, the Avian Flu and the Unrest in France in 2005 [3], the Global Financial Crisis in 2007, and the Ukraine Crisis in 2014 [4] and the recent escalation of geopolitical tensions. In summary, this situation is usually accompanied by some risk events, mainly geopolitical risks and financial risks, except for the two oil crises in the 70s, the global financial crisis, etc., most of the risks that need to be hedged come from the outside, and the US economy itself does not have too strong downward pressure. Judging from the data, most of the US manufacturing PMI are also in the rising range at these stages.
Figure 9: The U.S. economy is more resilient than the rest of the world, making the U.S. dollar and Treasury rates stronger, and the demand for safe-haven and hedging is more from outside the U.S
Source: Bloomberg, Haver, CICC Research
Take the 1983 Latin American debt crisis, for example, when the U.S. economy was recovering from stagflationary pressures, but a strong dollar led to external financial risks. In the early 80s, in order to break the stagflationary pressure, Volcker implemented a resolute austerity policy, which led to a phased recession. At this stage, the federal funds rate in the United States was above 10%, and the nominal interest rate was close to 10%. After the goal of controlling inflation was basically achieved, the Fed's policy gradually eased, and in 1982 the US economy began to recover quickly upward, and the PMI rose from 35.5 in May 1982 to nearly 70 at the end of 1983. The sharp pullback in inflation has pushed up real interest rates, as well as the high interest rate environment relative to other countries, which has led to a sharp increase in dollar-denominated external debt servicing pressure in Latin America. Mexico declared in August 1982 that it could not continue to service its $80 billion debt. Mexico's debt default triggered a Latin American debt crisis, affecting even less-developed-country (LDCs) around the world. According to the FDIC, after Mexico announced a $80 billion sovereign debt default, by October 1983, the world's 27 LDC countries had announced a total of $239 billion in debt restructuring, of which Mexico, Venezuela, Argentina, and Brazil accounted for $176 billion in Latin America. From September 1982 to May 1983, the 10-year Treasury rate rose by 13.6bp, while the dollar index and gold rose by 10.2% each.
So what will happen after the three rise together? The probability of turning into a decline after a month is close to 60 percent, and it basically gives up the previous gains. Historically, if all three rises occur at the same time this month, the frequency of gold prices turning lower in the next month and two months is 59.6% and 57.9%, respectively. On average, a one-month correction will not cause gold prices to fall beyond the point before the same rise, and the cumulative (starting to fall in the same month to the next month) will still have a gain of 0.2%, but after two months, the average cumulative return will fall to -2.9%. Therefore, this means that after the three rise together, the frequency of subsequent declines is more than half, and the previous gains are often given up within two months.
What is the outlook? Short-term overdraft, but the interest rate cut trade is not over, and the long-term logic can be used as a basis for adding when the opportunity cost is low
The divergence between gold, interest rates and the U.S. dollar is unsustainable in the short term, so gold is overdrawn before further rate cuts begin to push the U.S. dollar and Treasury rates downward. The short-term trend of gold is still constrained by the real interest rate of US Treasury bonds and the US dollar. The decline in U.S. Treasury rates in the fourth quarter of last year drove a rebound in economic and inflation data in the first quarter, leading to a continued delay in interest rate cut expectations, and CME futures are now expecting a rate cut in September and only one rate cut in the year. Based on the current real interest rate of 2%~2.2% (measured by TIPS bond yields) and the estimate of the US dollar index of 105-106, the short-term reasonable pivot of gold should be around $2,100 per ounce, but the continuous geopolitical risks and overseas local de-dollarization demand, and even optimism based on long-term logic have supported gold prices to remain high. At present, the gold trading point has been higher than the target point, and the deviation from the US dollar and real interest rates is large, and there is an overdraft in the short term.
Chart 10: CME futures are currently expecting a rate cut in September and only once a year
Source: CME, CICC Research
Chart 11: Gold is trading above the target and diverging significantly from the US dollar and real interest rates, and there may be an overdraft in the short term
Source: Bloomberg, CICC Research
Looking ahead, we believe that the current level of 4.7% in the U.S. Treasury interest rate has basically corresponded to no interest rate cuts within the year, and the expectation is relatively sufficient, and there is still room for decline in the future. We estimate that the real interest rate is 1.5%-2% (the nominal interest rate pivot minus 2~2.5% inflation expectations) and the US dollar index is 102-106 under the assumption that the reasonable pivot for gold is 2400~2500 US dollars / ounce. According to our analysis in "The Fed's Threshold for Rate Cuts" and "The U.S. Stock Correction Helps the Restart of the Rate Cut Trade", the resumption of the interest rate cut trade needs to be premised on a moderate decline in U.S. stocks and U.S. credit bonds (we estimate that a fall in the S&P 500 to 4,700 points and a 50bp widening of credit spreads can complete the "task"), and the less expected the rate cut is now, the more likely it is to promote the resumption of the interest rate cut trade, which corresponds to the third quarter. As a result, there is still room for gold to trade a wave of rate cuts after the restart of the rate cut trade until the rate cut starts once or twice and then ends.
Chart 12: We estimate that the real interest rate is 1.5%-2%, the US dollar index is 102-106, and the reasonable center of gold is 2400~2500 US dollars / ounce
Source: Bloomberg, CICC Research
As for the broader narrative of the long-term restructuring of the dollar's credit and monetary system, it is difficult to prove or falsify in the short term, and is more used as an assumption to reinforce the short-term view, and when the opportunity cost is low (financing costs are low and there are no other better investment options), the proportion of asset allocation can be appropriately increased.
1) From the perspective of US sovereign debt credit, repayment pressure does exist, but it is not appropriate to extrapolate too linearly too much. Since 2020, the U.S. has had aggressive monetary and fiscal policies that have led to a sharp expansion of the U.S. dollar, and the government debt ratio has reached a new high. Leveraging the public sector has protected private sector balance sheets, but it has also led to a significant increase in public debt pressure. Interest expenses alone account for 13% of current fiscal expenditures. In 2023, Fitch downgraded the US long-term credit rating to AA+[5] on the grounds of "high and increasing government debt burden", Moody's downgraded its outlook for the US from "stable" to "negative", and in March 2024, Phillip Swagel, director of the US Congressional Budget Office (CBO), warned that the US dollar as the world's reserve currency could come under market pressure as debt rises[6]. These are objective facts that exist at the moment, but we believe that discussions on long-term fiscal and debt stability should not be too static, and that the outlook for economic growth needs to be considered at the same time. In particular, it is necessary to take into account that the future pull of scientific and technological progress on the economy may increase fiscal revenue and reduce the level of fiscal expenditure required, so as to enhance the government's ability to repay debts. Looking back on history, during the Internet technology revolution in the 90s of the last century, labor productivity in the United States increased significantly, and government leverage fell significantly.
Figure 13: The U.S. has protected private sector balance sheets with government leverage, but it has also led to a sharp rise in public debt pressure
Source: Bloomberg, CICC Research
Figure 14: Looking back at history, during the Internet technology revolution in the 90s of the last century, the U.S. government's leverage has dropped significantly
Source: Haver, CICC Research
2) From the perspective of the safety of reserve assets, local de-dollarization needs may push up the reserve value of gold. After the collapse of the Bretton Woods system in the 70s, the dollar's status as a global monetary anchor declined, the dollar depreciated sharply, and inflation exceeded 14% due to two oil crises, and gold was also one of the best performing assets at this stage. Russia's dollar reserves were frozen after the Russia-Ukraine situation, which called into question the safety of the dollar as a reserve currency. Global central bank demand for gold has been strong since 2022, especially in the Asia-Pacific region. Since 2022, China's gold reserves have increased by 31.4%, Australia by 29.7% and Japan by 12.5%.
From a longer-term perspective, the frequent geopolitical situation, the restructuring of global supply chains, and the quasi-globalization of nearshoring and offshoring have greatly challenged the pattern of US dollar current account deficit outflows and financial account surpluses after the Bretton Woods system, and whether or not the third global monetary system anchor is being underway will have a significant impact on asset pricing, including gold[7]. The first two occurred in 1929 when the global monetary system first found anchor, and the major adjustment lasted for 16 years, during which the transition from the gold standard to the gold bar/gold exchange standard, and in 1944, a new monetary system was established - the Bretton Woods system, and gradually transitioned to the credit currency stage, "the dollar is pegged to gold, and the currencies of various countries are pegged to the U.S. dollar". 2) In 1971, the US dollar was decoupled from gold, the Bretton Woods system collapsed, and the global monetary system began to find anchors for the second time, canceling the currency peg, and the central bank had more power to issue money and more complex policy objectives. Economies are beginning to stimulate economic growth in their own ways, and the dollar's position has declined marginally but remains an important pole.
Figure 15: The Global Monetary System Finds Its Anchor Three Times
Source: Bloomberg, CICC Research
[1]http://www.xinhuanet.com/world/2016-08/11/c_129221279.htm
[2]https://ciss.tsinghua.edu.cn/info/china_wzft/1412
[3]http://www.xinhuanet.com/world/2018-01/04/c_129782274.htm
[4]http://cpc.people.com.cn/n/2015/0109/c187710-26358071.html
[5]https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-01-08-2023
[6]https://wallstreetcn.com/articles/3711320?keyword=%E7%BE%8E%E5%9B%BD+%E5%80%BA+
[7] Quoted from "The Third Anchor of the Global Monetary System", by Huang Haizhou
Article source:
This article is excerpted from: "What happened to the last time gold interest rates rose with the dollar?" published on April 28, 2024.
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