Like other commodities, supply and demand play a role in the price of Gold. But unlike other commodities, even other precious metals like silver (electrical appliances, superconductors, batteries) and platinum (automobile production inputs), gold has few if any industrial uses on a widespread scale.

As such, rather than consumption playing the primary driver for gold prices, saving and disposal are the central factors. When we mean ‘saving and disposal,’ we mean reasons like as a hedge against inflation, a safe haven during times of market duress and geopolitical stress, or as an alternative to fiat currencies during periods of low or negative interest rates. Currently, a mix of these factors are driving Gold’s push higher.

Interest Rates Play a Dominant Factor in Gold’s Appeal

Real yields are inflation-adjusted yields: in this case, the US Treasury 10-year yield minus the headline inflation rate. Why does this matter? Investing is all about asset allocation and risk-adjusted returns. On the asset allocation side, it’s about achieving required returns given the investor’s wants and needs.

If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing? On a real basis, your returns would be lower than otherwise intended.

Price Chart 1: Spot Gold versus US 10-year Real Yield Daily Timeframe (February 2011 to 2018)

For example, let’s say the US Treasury 10-year yield is currently 2.5% and headline inflation is 2%. The nominal interest rate is 2.5%, and the real interest rate is 0.5%. Then all of the sudden if inflation shoots up to 4.5% while US yields held steady, the real interest rate would move to -2%.

Falling US real yields means that the spread between Treasury yields and inflation rates are decreasing. If Gold yields nothing, has an estimated cost of carry of -2.4% and only can return capital appreciation, it would best suited to rally when US real yields fell.