Gold is often viewed as a safe haven for global uncertainty and market turbulence. Unlike investments which derive their value based on the faith and credit of the issuer — such as currencies, stocks and bonds — gold and other precious metals are seen as a tangible asset that will always have value.
Gold is a global commodity, and its price is subject to global forces of supply and demand. For most of 2019, gold has hovered around $1,300/oz. But a recent surge in gold has sent the price of the yellow metal soaring — gaining $141.60, or 11.1%, in less than a month. On Tuesday, gold reached $1,418.70/oz., its highest price since August 2013. The record price for an ounce of gold is $1,891.80, set back in August 2011 from the fallout of the subprime mortgage crisis.
So, what exactly triggered this recent investor demand for gold that sent its price to a near six-year high? Yes, gold serves as a hedge against the concerns that continue to weigh on U.S. economic growth, most notably our ongoing trade dispute with China and a weakening global economy. But the main driver has been the June 3 policy shift by the U.S. Federal Reserve to potentially start lowering interest rates.
Though the Fed is not formally projecting any rate cuts this year, it has now expressed a willingness to jump in and start cutting rates if it continues to see strains on economic growth. The markets deem this willingness as an implied path to future interest rate cuts later this year. In fact, the markets are now expecting between two to three rate cuts this year with about a 75% chance the first rate cut will be in July.
Gold prices are extremely sensitive to changes in interest rates. As interest rates rise, gold tends to decline. Apart from any price appreciation determined in the open market, gold bears no dividend or interest payments. It must compete with interest-bearing investments, such as bonds, for investor funds. As interest rates rise, investors typically shed non-yielding assets such as gold in search of higher yields from other types of investments. However, with the Fed now expected to cut interest rates, there is less of an opportunity cost in buying gold as a safe haven investment. In other words, investors are now more willing to buy gold because the interest payments they could receive on other investments are relatively low.
Where gold prices will go from here is unknown, but the timeline on a final trade agreement with China will be the biggest factor. A quick resolution would alleviate many of the constraints placed on U.S., Chinese and global economic growth. Thus, the Fed, along with other nations’ central banks, would be less likely to cut interest rates to boost their respective economies. But if this trade dispute continues, the Fed will feel pressured to cut interest rates to spur economic growth, keeping upward pressure on the price of gold.