Gold (NYSE: GLD) has been in a bull market since late 2018, gaining nearly 25% since it bottomed around $1,175. During this period, the yield on the 10-year note was around 3.3%, and there were expectations for three or four rate hikes in 2019. Therefore, it's not a coincidence that gold moved higher as the U.S. economy decelerated due to concentrated weakness in manufacturing, and the Federal Reserve made a dovish pivot. In turn, long-term and short-term interest rates dropped to near-record lows with the 10-year yield bottoming out around 1.4%.
Drivers of Gold Demand
Demand for gold is most affected by real interest rates especially on a short-term basis. Real interest rates are interest rates subtracted by inflation. So if the interest rate is 3%, and the inflation rate is 2%, then the real interest rate is 1%. Since gold is a hedge against inflation, but it doesn't earn any interest, it declines when real interest rates rise. If the risk-free return is 2%, that is also the opportunity cost of holding gold. Gold demand declines as this cost increases.
From late-2018 to now, real interest rates have steadily moved lower due to inflation steadily moving higher, and interest rates dropping. Looking forward, this dynamic is likely to persist and provide support for gold prices for much of the year. The Federal Reserve has clearly set its intention to not hike rates until inflation is "persistently" above its target. However, core CPI and other inflation measures are at the highest levels since 2011.
Increased Political Risk
Another contributor to gold demand is political risk. During periods of heightened political risk, investors flock to the safety of gold. Although asset markets are buoyant, there is an undercurrent of political risk given a number of combustible situations with Iran, North Korea, and China in addition to a volatile President obsessed with his reelection in an election year.
The last major bull market in gold was from 2001 to 2008 when it rose from $200 to above $1,000. This coincided with the last major occupation in the Middle East and also booming fiscal deficits during an expansionary period which forebodes scary things for when the US enters a recession.
Next Move
Following the Iran news, gold shot up to nearly $1,600 before quickly giving back more than $50 as odds of an intense confrontation remain distant. In the short-term, some more consolidation seems likely, however investors should continue to look to buy dips. Fundamental factors remain supportive. If inflation drops, the Fed is prepared to cut rates more. If inflation surprises on the upside, the Fed will not hike for at least a year.