Gold will have its glory day, but don’t jump the gun

The trigger for the latest jump in gold has been the spectacular fall in real 10-year US bond yields (TIPS) to minus 0.92pc.  Specifically, the 10-year breakeven rate capturing inflation expectation is shooting up, but at the same time the Fed is holding down nominal rates by financial repression. It is this scissor action that drives the gold price.

“That is what has prompted the speculative moves over the last two weeks. There is a sense of incipient inflation and hedge funds are piling in,” says Adrian Ash from Bullion Vault. “You have also got the private Swiss banks recommending a 10pc allocation in gold.” 

Behind the move lies a powerful slower-moving force. Central banks are no longer selling gold. Gordon Brown’s give-away sales of British bullion seem extraordinary now.

Russia’s central bank has been soaking up 80pc of the country’s gold production, taking the world’s third biggest source of mine supply off the market.  China, India, and Turkey have been accumulating, but so have Poland, Hungary, Bulgaria, and the Czechs. Central banks bought a net 656 metric tonnes in 2018 and another 650 tonnes in 2019, the highest levels in fifty years.

 “It has been absolutely phenomenal, but right now gold has got ahead of itself and needs to catch its breath,”  said Ross Norman, a veteran gold trader at Metals Daily.

Needless to say, the Fed denies that it is debauching the dollar, insisting that the Covid shock has left rampant over-capacity and will be “disinflationary” for years to come. Former Fed chair Ben Bernanke told Congress last week that markets were wrong to bet on inflation when QE was first launched, and they are just as wrong now.

He has a point. Real rates collapsed in much the same way in 2012 yet it proved to be a false alarm. Equities did inflate but consumer prices did not not. Inflation fell for the next three years. So the question is whether something has fundamentally changed in monetary dynamics since then. 

Professor Tim Congdon from International Monetary Research says QE did not catch fire last time because the Western banking system was broken, and Basel regulation made matters worse by forcing lenders to raise capital buffers. Central banks had to ramp up QE to offset the ensuing destruction of broad M3 money. 

Lenders are now in better shape and the Fed’s $3 trillion blast of QE since March has this time led to a 27pc rise in the M3 money supply year on year, the fastest rise since the war time surge in 1943. The money sits in bank accounts waiting for inflationary ignition once life returns to normal. The Fed could hoover up the excess liquidity before this happens but clearly has no intention of doing so.