Does the gold rally have more steam left?

Gold has seen a phenomenal rally over the last couple of months. Between 12th February 2024 and now, gold has risen 17%. During the same period S&P 500 is up 3.6%, DXY is almost flat and US 2Y yield has risen from 4.47% to 4.75% i.e. 28bps.

Gold has rallied despite ‘risk on’ and despite rates firming up which is quite unusual. These correlations are hard to comprehend and therefore one needs to enquire if any other dynamics are at play.

The US government is piling on debt at a tremendous pace and US procyclical deficit spending is perhaps what is keeping the labor market and economy afloat despite such elevated interest rates.

The US fiscal deficit as a percentage of GDP was 5.3% in 2022 and 6.2% in 2023, elevated by historical standards when the economy has been normal. Debt to GDP which had spiked post COVID, seems to have stabilised around 120% of GDP.

Shifting sands of global geopolitics and global trade dynamics coupled with concerns around US fiscal profligacy could be responsible for the surge in gold prices we are seeing right now.

The de-dollarisation narrative has been around for long. It was always believed that de-dollarisation would not happen overnight and that it was likely to be a long drawn process. One can’t help but wonder if it has started manifesting itself and whether this is just the beginning. Looking at the US dollar against a basket of other major fiat currencies may not reveal the true picture as other economies are not sailing in a boat which is very different. Therefore, the dollar may not weaken as much against other major currencies. Gold could be the biggest beneficiary of the de-dollarisation theme.

Also, as other central banks look to increase their holdings of gold and buy fewer US treasuries, the Fed would have to think about ending balance sheet rundown sooner.

Besides the question of when and how much the Fed would cut rates, the question of when it will level off its balance sheet is equally important.

The US interest expense has soared to 2.4% of GDP and is likely to rise even further. This compares with an average of around 1.4% of GDP in 2015-2020.

The US government will need help from the Fed to contain its interest expense considering the size of treasury issuances on account of higher deficits and refinancing of maturing debt.

We, therefore, prefer holding on to long gold positions and also believe long duration in US treasuries is a position that could be rewarding over the medium term.

(The author is Founder and CEO IFA Global)

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times.)