Gold surges, even before Fed cuts

Gold prices are breaking new record highs, buoyed by the prospect of lower US interest rates and strong buying by central banks.

Recent higher-than-expected inflation figures will not sway the US central bank from its plans to cut interest rates, Federal Reserve chair Jerome Powell said in a speech made at Stanford University in California.

Powell confirmed that he still believed that the Fed would begin lowering rates "at some point this year".

Based on recent comments by Powell, traders are pricing in two cuts to interest rates this year.

This dovish outlook from the Fed has lit a fire under gold prices, already supported by the risky geopolitical outlook and strong buying by central banks. Gold price futures pushed above $2,300/oz on April 3 as treasury yields and the dollar sank.

Divergence from yields

Unlike previous gold rallies, in 2011 and 2020-21, interest rates remain elevated, with the current boom coming in anticipation of future rate cuts rather than in response to them.

"We note the persistent divergence between US Treasury yields and gold prices, which have traditionally moved in tandem," SP Angel said in a note.

SP Angel said that this "presents a bullish case for gold".

"In the scenario of lower yields amid a potential labour market slowdown, funds will rotate into physical gold ETFs as their bond returns lessen, providing an additional catalyst for bullion."

But SP Angel warned that the market had front-run a potential slide in treasury yields. If policy changes direction, for example, in response to higher inflation or US employment, that could leave gold "vulnerable to a pullback".

Central bank buying

Gold investor Sprott also saw reasons for further bullishness.

"We believe several fundamental factors are in place for gold to potentially move higher, particularly strong central bank buying," Sprott said.

"Central banks' strategic shift toward gold creates a new dynamic in gold pricing, breaking historical correlations," Sprott said. "Their motivations and needs differ significantly from investment funds."

Central banks added a net 19t to their gold reserves in February, according to the World Gold Council. China added 12t, while India and Kazakhstan added 6t each.

Ole Hanson, at Saxo Bank, noted the role of political risk in driving prices higher.

"With rate cuts on the horizon, we envisaged a weaker dollar and lower real yields would lead to a pickup in demand for ETFs from real money managers," Hanson said.

"Neither of these have yet materialised, and instead gold has been driven higher by hedge funds, or speculators enjoying the strong momentum that has been set in motion by strong demand from investors around the world responding to heightened geopolitical tensions and debt-financed growth."