While gold has seen its best week in two years, one U.K.-based research firm expects that the rally will not be sustainable, looking for prices to fall nearly 6% from current levels by year end due to rising real interest rates.
Capital Economics said in a recent report that although gold is traditionally a good hedge against inflation -- as the yellow metal rises in conjunction with consumer prices -- the impact of inflation would be offset by rates rising at a faster pace.
“In our view, the positive impact on gold prices from higher demand for inflation hedges could be more than offset by rising real interest rates,” the report said.
In the report, the firm reaffirmed its forecast that gold prices would end the year at $1,270 an ounce, down 5.9% from Friday’s settlement price of $1,349.90 an ounce.
Gold has historically been inversely related to real interest rates, but the firm noted, there has been a widening divergence in this correlation ever since the December 2017 Fed meeting. Gold has since rallied despite persistent downward pressures on real rates, making the yellow metal appear overvalued.
The report added the as the economy heats up, the Fed would have to adopt a more hawkish stance and hike rates “significantly beyond their neutral level in order to limit the increase in inflation.”
The other factor driving gold prices up is a depreciating U.S. dollar, the report said. The dollar and gold have consistently held a strong negative correlation as the two are often seen as substitutes.
The FOMC stumped more hawkish analysts this week by forecasting only three rate hikes this year, sending the U.S. dollar lower and in turn boosting gold prices higher. However, Capital Economics doesn’t expect the dollar to depreciate further this year, meaning gold could lose support from a major tailwind factor.
The report said that lingering geopolitical tensions could occasionally counteract gold-bearish forces. “To be sure, heightened geopolitical risk could, at times, give some support to the gold price and was probably a factor behind its resilience in recent weeks,” it said. “But ultimately, we think that the balance of risks for gold prices lies to the downside this year.”
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