When interest rates rise and real rates on government bonds turn positive, the price of gold usually falls, but that is not what has happened over the past 18 months, says James Luke, fund manager, metals at Schroders. 

Gold prices are now hovering around $2000 per ounce, which is around the all-time highs. What makes it unusual is that gold is at these levels despite a very significant increase in real interest rates in the US over 2022 and 2023. .

Before 2008, gold really traded more of its commodity characteristics (including jewellery demand and with emerging markets currencies) and less in line with real interest rates. The real pivot point was following the 2008 Global Financial Crisis, a broad policy response of quantitative easing was introduced, which in effect just meant printing money to buy more government bonds to suppress interest rates.

From an investor perspective, this change raised concerns about long-run monetary debasement and caused a strong underlying bid for gold because of its monetary characteristics.

For nearly 15 years, the relationship between gold and real returns on bonds was strong. They remained happy bedfellows from an investment perspective. Then something went awry and forced a breakup.

Fed policy, and then investment and demand for gold as a monetary asset in the West, are still very much connected and we can really see that in the data.

This time round, as in 2013, the Fed has tried to normalise policy. They have started to reduce their balance sheet, i.e. implement quantitative easing. They have also significantly raised interest rates, which has put the opportunity cost up of holding gold.

And what have we seen? Physical ounces held in ETFs in the West fell significantly, some 25+ million from the peak.

In recent quarters, we have seen European demand for gold bars and coins fall significantly, particularly in Germany. And we have seen very moribund financial market sentiment for the gold market. These relationships have not suddenly disappeared. It is just that their impact on the gold price is lower because another source of demand has become so strong as to offset those negative selling pressures in the West.

Real interest rates really started to accelerate higher in early 2022, and it was at that point that the paths of gold prices and real interest rates really started to diverge.

With gold prices since that time having fluctuated between below $1,800 an ounce to above $2,000 an ounce, staying relatively high versus what real interest rates have done, the pivot point seems to have been the first quarter of 2022. That coincides with when the Russia-Ukraine conflict began.

The biggest delta on the gold demand side has been central bank demand, which is directly related to the Russia-Ukraine conflict and the West’s response to the situation.

Besides central banks, demand for gold bars and coins has also been very strong in China and also in the Middle East, reaching clear record levels according to World Gold Council data.

If you compare 2013 or even earlier periods in terms of Chinese retail demand or public investment demand, there is a stark contrast. With capital lacking a home to go to, gold has been a beneficiary.

By James Luke, fund manager, metals at Schroder Investment Management