Why Is Gold Going Up?

While the world has watched stocks continue to surge on enthusiasm for AI and stronger-than-expected earnings, an investment as old as civilization itself has also quietly been gaining ground in 2024.

Gold prices have risen by about 4.6% year-to-date, a development that has surprised some observers due to the currently high rates of interest being paid on bonds.

Why is the flagship precious metal rising, and will this trend continue through the rest of this year?

Pending Rate Cuts and Inflation Fears Are the Primary Drivers

The consensus view behind gold’s recent surge appears to be anticipation of interest rate cuts from the Federal Reserve later this year. While the central bank held rates steady in its latest meeting, it still foresees three rate cuts in 2024.

The market is primarily anticipating the first of these cuts to come in or around June. Like the stock market, commodities markets appear to be pricing these expected cuts into the price of gold.

The expectation of lower rates has historically provided buoyancy to gold prices. While exceptions can certainly be found, particularly in the high interest rate environment of the 1970s, gold typically becomes slightly more attractive as bond yields fall.

With less reward for investing in other safe assets, investors sometimes turn to gold due to its historical ability to hold its value against inflationary pressures.

It’s worth noting that the rising price of gold may very well signal investors’ belief that inflation hasn’t yet been fully tamed.

If a cut in rates provides a catalyst for higher inflation going forward, the price of gold is likely to rise further in response. Historically, gold is seen as an investment hedge against inflationary pressures.

There is at least some evidence to suggest that a renewed wave of inflation is possible. To begin with, inflation once again ticked up modestly in January and February, suggesting that the Fed’s policy of tighter rates could represent a premature declaration of victory against rising prices.

Commodity prices are also rising, a frequent leading indicator of future inflation. In addition to gold, prices for copper, oil, silver and other basic materials are also trending upward.

Other Forces Acting on Gold

While expectations of lower interest rates appear to be providing the main upward pressure on gold, it’s worth acknowledging that there are also other supporting factors. Chief among these is buying activity from central banks.

The central banks of China and India, in particular, have been padding their gold holdings in recent years in an attempt to diversify their reserves. Central bank purchases in 2022 and 2023 more than doubled their total from 2016 through 2019, indicating a strong appetite for the metal as a guarantor of stability.

Geopolitical tensions also seem to be driving the price of gold higher. In addition to ongoing conflicts in Gaza and Ukraine, continued interruption of Red Sea shipping by the Houthi in Yemen has provided fertile ground for higher gold prices. This effect can be seen acutely, as the price of gold moved noticeably higher in January when US forces escalated operations against the Houthi by striking targets in Yemen directly.

To some degree, rising gold prices may also signal a lack of confidence in American fiscal and monetary stability. In particular, rising government debt could be attracting retail gold investors to the precious metal.

Gold prices and US debt levels have historically had a direct relationship, as higher levels of debt can erode confidence in both stability and future growth.

With the national debt rising at a record pace at potentially posing serious risks to growth by the end of the decade, gold’s appeal as a stable store of value may be creating additional demand among investors.

Will Gold Continue to Rise?

While the near-term price of gold will depend heavily on whether inflation begins to rise again or not, it appears likely that gold prices will continue to move upward throughout the year. Goldman Sachs forecasts a roughly 6% increase in spot prices over the coming 12 months, outpacing the current 10-year treasury average of about 4.27%.

Looking further down the road, it’s probable that further gradual rate cuts from the Federal Reserve in 2025 and beyond could drive gold prices progressively higher.

Additional inflation, if it materializes, could bolster these tailwinds. To the extent that rising national debt is driving up demand for gold, it’s also likely that continued borrowing in the US will create the conditions for prices rising beyond their present levels.

Is Gold a Good Investment?

Although gold will likely produce positive returns over the next year, it’s still very likely to underperform the American stock market.

Analysts predict an 8% increase in the S&P 500 over the coming 12 months, outpacing expectations for gold by about 2%. It’s worth noting that this would be a period of relatively anemic growth for the benchmark index by historical standards.

Over time, the performance of the stock market has massively outpaced returns on gold. This point was perhaps most cogently made by Warren Buffett during Berkshire Hathaway’s 2018 annual meeting.

In an attempt to illustrate the differences between productive and non-productive assets, the legendary investor walked his audience through the performance of gold and the S&P 500 since 1942, the year Buffett made his first stock investment.

The results favor stocks, to say the least. A $10,000 investment made in the S&P 500 in 1942 grew to $51 million at the time Buffett made his presentation. By contrast, a $10,000 investment in gold made at the same time appreciated to only about $400,000.

While gold can serve as a store of value, especially during periods of high inflation, the precious metal hasn’t shown the same capacity as stocks to generate compounding returns over many decades. As such, investing in a diversified portfolio of high-quality stocks or in broad index funds is likely still the better bet for long-term growth.

Stock investments are also typically better for generating income because a portfolio of stocks can be constructed to include dividend-yielding holdings.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.