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Gold prices dropped to $1,772 per troy ounce this week, reaching their lowest level since November last year. In euros, the price fell below €47,000, the lowest level since April last year. This is despite the fact that the precious metal achieved its biggest price increase in ten years last year, shattering the old record of $1,920 per troy ounce. Why is it that the Gold price is under pressure again after last year's increase? In this article, we will discuss the main causes of the price drop.
Last year, the corona crisis caused a flight to safe havens. At the same time, central banks lowered interest rates and started buying bonds again on a large scale. As a result, interest rates on government bonds fell to an all-time low across the board, in many cases even below zero. This resulted in a Flight to precious metals, because no interest rate is more attractive than negative interest rates. Interest rates initially remained low, but have risen steadily in recent months. Things are going particularly fast in the United States, as investors expect more inflation due to huge fiscal stimulus programs. As a result, they charge a higher interest rate to lend their money to the U.S. government.
At the time of writing, the U.S. 10-year yield is around 1.3%. This is the highest level since February last year, when the coronavirus pandemic spread from China to the rest of the world. Rising interest rates are making government bonds more attractive against the precious metal. The chart below shows that the price of gold and interest rates in the United States are highly correlated. It should be noted that real interest rates - i.e. after correction for inflation - rise at a much slower rate. In addition to interest rates, inflation expectations have also risen.
Gold price under pressure due to rising interest rates
Interest rates are rising, but investors also expect higher inflation
Many investors who Buy gold see it as a safe haven in uncertain economic times. Due to the corona pandemic, the economic outlook looked very bad, but the damage has been limited for the time being due to support measures from governments and central banks. The number of bankruptcies is low, because unprofitable companies are also kept afloat by government support. As a result, unemployment has not risen as quickly as initially feared.
The U.S. government, under the leadership of the new President Joe Biden, wants to $1.9 trillion to keep the economy going. Part of this support program is the one-time distribution of money to all American households. Some Americans really need that to make ends meet, but for most people, it's a perk they can spend on fun things. The effect of this is already visible, as retail sales in the US fell sharply in January. Largest increase in seven months. Industrial production figures were also much better than expected.
These positive economic figures put pressure on the price of gold as a safe haven. The prospect of economic recovery through fiscal stimulus is currently reason for investors to prefer equities over precious metals. The fact that investors have more confidence in the recovery of the economy is also evident from the price development of other precious metals. While gold is falling, we see silver and platinum continue to rise in price. These precious metals also have many industrial applications and are also benefiting from economic recovery.
A third possible explanation for the falling gold price is that more investors are now buying Bitcoin. Since the beginning of this year, the price of the virtual currency has more than doubled to $50,000. In addition to private individuals, more and more institutional parties are also getting involved Bitcoin. Tesla bought $1.5 billion worth of Bitcoin, while MicroStrategy plans to invest another $600 million in the virtual currency with a new equity offering. Mastercard also wants to facilitate payments in the virtual currency.
Last year, investors stepped in for $5.6 billion in funds that invest in virtual currencies, an increase of 600% compared to a year earlier. By comparison, last year investors got into a record amount of $47.9 billion in gold ETFs. The gold market is still a lot bigger than that of virtual currencies, but the second is growing faster. It is therefore plausible that more investors are currently buying Bitcoin and that the gold price has come under some pressure as a result. Below you can see the price development of the precious metal and the virtual currency since the beginning of last year.
Gold price development versus Bitcoin
The gold price is currently facing headwinds due to rising interest rates, positive expectations about the economy and a flight to virtual currencies. In the short term, this could put further pressure on the price, but in the longer term, we remain positive on the precious metal. Rising inflation expectations and accommodative monetary policy will further erode the purchasing power of money. Historically, tangible assets such as precious metals, real estate and the like perform well in times of currency depreciation.
We may also be able to add Bitcoin to the list of safe havens, but by High volatility the virtual currency is not for everyone. Gold is a much safer alternative to the savings account that no longer yields interest. The precious metal also has a proven track record as an instrument that manages to maintain its purchasing power in the long term. Central banks also hold large gold reserves that they can use for a monetary reset. Due to the drop in prices, gold may now be an attractive alternative to stocks or virtual currencies.
Disclaimer: Holland Gold does not provide investment advice and this article should not be considered as such. Past performance is no guarantee of future results.
