Gold spot prices have recently hit an all-time high, surpassing $2,500 per troy ounce. But the key question is: What's driving this surge? It could be tied to investors anticipating an imminent recession or betting on interest rate cuts by the Federal Reserve and further declines in long-term interest rates. Alternatively, it might reflect a strong movement of investors seeking refuge in gold amid growing geopolitical tensions and an increasingly uncertain macroeconomic scenario.

Before delving into the factors behind gold's rise, it is important to note that one of the most practical and popular ways to gain exposure to this commodity is through exchange-traded funds such as the iShares Gold Trust (IAU, Financial). This ETF is designed to reflect the performance of gold and is not actively managed. As shown in the chart below, the ETF has reached an all-time high, mirroring the performance of the metal itself.

In this analysis, I will explore why gold has reached all-time highs and examine the factors behind this movement.

Gold's all-time highs: Nominal versus inflation-adjusted values

When analyzing the gold price chart, the performance of this precious metal from the 1970s—when it was valued at less than $100—to late August this year when it peaked at $2,524, is truly remarkable, especially considering the substantial increase in value following the Covid-19 pandemic.

However, it is important to put this nominal price into historical context. Although gold is currently at an all-time high nominally, the highest price, when adjusted for the dollar's loss of purchasing power, would be different.

On the nominal chart, gold reached $682 in January 1980. Now, as of August 2024, it stands at an all-time high of $2,510. However, when adjusted for inflation, gold's price in January 1980 would be equivalent to $3,405 in 2024 dollars. In September 2011, the inflation-adjusted peak was $2,626. While gold's current price of $2,531 is just above the 2011 high, it still has a significant distance to cover to exceed the 1980 high. To surpass the inflation-adjusted all-time highs, gold would need to rise by about $900 more.

It is also worth noting that gold demand in the 1980s was driven by rampant inflation and high interest rates. While these factors still play a role to some extent, the current situation is more complex.

What explains the recent gold rally?

There are a few big factors at play that explain why gold has been on such a hot streak lately. One major player is the long-term real interest rate, which we can track using 10-year U.S. Treasury Inflation-Protected Securities, or TIPS.

If you look at how gold and TIPS move together, you will notice an interesting pattern. In the chart below comparing the iShares Gold Trust ETF and the iShares TIPS Bond ETF (TIP, Financial), you can see that when interest rates fall, gold prices often rise. This indicates a negative correlation, where the correlation coefficient is often below zero, meaning that as real interest rates decrease, gold prices tend to increase. A correlation coefficient below one (but above zero) suggests a positive correlation, but not a perfect one. Essentially, as real interest rates decline, gold becomes more attractive because it does not generate income, making it a more appealing investment.

Source: YCharts

Although the correlation between gold and TIPS is not always perfect, there has been a noticeable trend in recent months, especially since May. However, during other periods, such as March and April 2024, when interest rates increased, gold prices also rose. This indicates that factors beyond just the opportunity cost are influencing gold prices.

For example, the American yield curve has seen a significant decline, with the 10-year Treasury yield falling below 3.80%, a level not seen since July of last year. Such movements often precede recessions, as investors seek safety by buying long-term bonds or gold during economic contractions.

Additionally, falling fuel prices—particularly since April and even more so since October of last year—for oil, gasoline and diesel, indicate reduced economic demand, suggesting a potentially shrinking economy, especially impacting transportation and industrial activity.

To add more precision to the idea that this trend suggests a potentially contracting economy, consider the relationship between copper and gold. Copper, widely used in industrial and capital goods, typically decreases in price during economic slowdowns, while gold prices tend to rise, reflecting a shift toward safety over growth. Currently, the copper-to-gold ratio is near historical lows, indicating a potential recession. This helps explain the increasing interest in gold during periods of economic decline.

Source: MacroMicro

Last but not least, geopolitical tensions add complexity to these trends. Increased friction between the West and countries like China and Russia drives demand for gold as a secure, non-confiscable asset. These nations' central banks, along with their citizens, continue to seek gold as a safeguard and store of value, especially in response to financial sanctions imposed by the West.

The bottom line

Gold's recent rise is not surprising. Anyone familiar with monetary history and the role of gold as a protective asset would expect such a move, especially during times of potential recession or geopolitical tension. Gold continues to be highly sought after in these circumstances.

Is there room for further increases? It is quite possible. While the price has reached new highs, further significant drops in long-term interest rates would be required to drive prices even higher. Predicting these movements, especially in the short term, remains challenging. However, what remains clear is that gold's role in the economy is unchanged.

Despite several decades of attempts to demonetize gold, the "barbarous relic" popularized by John Maynard Keynes has retained its significance. Governments have not succeeded in removing its role as a fundamental asset. Gold remains a crucial safeguard for investors and central banks, and it is wise for every investor to consider it as part of their portfolio.