Guojun: Q3 is highly likely to be the starting point of the second major upswing in gold for the year

Introduction

Since 2018, the real interest rate of US Treasury bonds can still explain the short-term fluctuations of gold, but the determining factor for long-term trends has shifted to the Renminbi exchange rate. This pricing logic perfectly explains the gold market in March-April 2024 - the temporary decline in US Treasury bond rates is the catalyst, while the Renminbi exchange rate holding a key level is the booster. Using this framework to assess the future trend of gold, Q3 is likely to be the starting point for the second major upswing of the year for gold, with the central bank expected to increase its gold holdings again, which could become an important driving force.

Summary

1. Has the pricing anchor of the real interest rate of US Treasury bonds really failed?

The essence of the real interest rate of US Treasury bonds: To compensate for its relative credit disadvantage compared to gold, providing additional interest income compensation. Therefore, theoretically, the real interest rate of US Treasury bonds is negatively correlated with gold. However, after 2022, the trends of the two have diverged. But if the trend items of the two since 2022 are excluded, the correlation returns. In other words, the real interest rate of US Treasury bonds can still explain the short-term fluctuations of both, but it no longer has explanatory power for the long-term trend of gold.

2. Considering another variable, can the US dollar credit explain this divergence?

The compensation of US Treasury bond real interest rates for credit is based on the premise of unchanged credit. If credit begins to deteriorate, the same real interest rate is obviously no longer attractive. This logic perfectly explains the first decade of the 21st century: US Treasury bond real interest rates fluctuated at high levels (around 2%), while gold trended stronger. But it cannot explain the story since 2022 (US dollar fluctuating, gold repeatedly hitting new highs). In other words, even when the US dollar credit is not bad and the real returns are good, there are still people who do not accept the US dollar and embrace gold.

3. An important phenomenon - the increasing correlation between exchange rates of various countries and gold.

Starting from a strange phenomenon: since the marketization of the RMB exchange rate in China, the correlation between the RMB exchange rate and gold has gradually strengthened, leading by 6 months. Considering the pressure stage of our country's exchange rate, the US dollar is strengthening, theoretically bearish for gold (the actual situation is that gold is strongest after the pressure on the Renminbi exchange rate). Similar things have also happened in other countries - the UK, Japan, India, Russia, where the exchange rates of multiple countries have reached highs since the 21st century, and exchange rates have turned positively correlated with gold.

4. A significant force supporting the price of gold - a few Asian central banks represented by China

In theory, the normal operation of stabilizing the exchange rate is: selling US Treasury bonds and withdrawing local currency. However, some central banks have added the operation of "increasing gold holdings" on this basis (representative countries: China, India, Russia, and others). The logic behind this may be twofold: firstly, if the strengthening of the US dollar is not a cyclical phenomenon but a trend phenomenon, the effect of controlling the exchange rate through supply and demand weakens; secondly, as gold is the highest credit currency, the disadvantage is the lack of interest, if incremental funds bring stable capital gains for gold, it can compensate for interest, counteracting the US dollar 5. The systematic shift in the pricing logic of gold - anchored by the RMB exchange rate.

From this perspective, since 2018, the actual interest rates of US Treasury bonds can still explain the short-term fluctuations in gold, but the determining factor for long-term trends should be the RMB exchange rate. This pricing logic perfectly explains the gold market in March-April 2024 - the temporary decline in US Treasury rates acted as a catalyst, while the RMB exchange rate holding a key level acted as a booster. Judging the subsequent trend of gold within this framework, Q3 is likely to be the starting point for the second major upswing in gold for the year, with the expectation that the central bank will increase its gold holdings again, potentially becoming an important driving force.

6. Risk Warning: Resilience of the US economy exceeds expectations, economic recession in non-US economies.

Author: Han Zhaohui S0880523110001, Zhang Jianyu S0880124030031, Source: Guojun Macro Research, Original Title: "Rethinking Gold: Systematic Transformation of Pricing Paradigm - Commodity Outlook Series II"