Geopolitical conflicts are driving up energy prices and inflation risks, with markets pricing in a Federal Reserve rate hike this year. Real yields continue to rise, and gold has been firmly suppressed below the $4,200 per ounce mark in recent times. Jefferies, through a review of multiple historical cycles, points out that the shift in interest rate expectations is far more critical than the absolute level of rates. Although there are numerous short-term bearish factors, supported by robust underpinnings like geopolitical risks and central bank gold purchases, gold and gold mining stocks still have room for valuation recovery. Once the pressure from real yields eases, gold prices are expected to stage a rebound.
Rate Hike Expectations Heat Up, Weighing on Gold
The outbreak of the US-Iran conflict has disrupted transportation through the Strait of Hormuz, impacting about 30% of the world's oil supply. The energy crisis has pushed up oil prices, reigniting inflation concerns. As a result, the market is pricing in two rate hikes by the Federal Reserve this year, with the first likely occurring in September. At the July FOMC meeting, three Fed members voted in favor of a rate hike, further solidifying market tightening expectations. This rapid reversal in interest rate expectations is directly pressuring gold's performance. Jefferies analysts note that the real yield on 10-year Treasury Inflation-Protected Securities has risen significantly. Market rate expectations have shifted from expecting one to two rate cuts at the start of the year to entirely expecting one to two rate hikes. This drastic shift in expectations has driven gold prices down approximately 25% from their peak. As a non-yielding asset, higher real yields increase the opportunity cost of holding gold. When interest rate expectations adjust rapidly, gold prices tend to experience sharp pullbacks. The firm reviewed multiple historical tightening cycles, including the 2013 Taper Tantrum, the 2018 peak in real yields, and the 2022 rate hike cycle. In each case, gold and gold mining stocks suffered deep short-term corrections. However, the performance in the year following these corrections varied greatly. The key factor was not whether real yields rose, but whether the subsequent pressure from real yields could be marginally alleviated.
Bearish Factors Have Been Priced In, Multiple Underlying Supports Remain Solid
Despite the short-term bearish market environment, Jefferies maintains a relatively optimistic outlook for gold in the later part of the year. Gold and the gold sector have already undergone a clear round of valuation repricing, with most of the bearish factors already reflected in the price. The firm emphasizes that the direction of change in real yield expectations is more important than the absolute level of real yields. The price of gold cannot be determined simply by the single dimension of real yields. Central banks' continued gold purchases, geopolitical uncertainties, US fiscal concerns, the de-dollarization process, and global institutional demand for hard assets collectively form the underlying support for gold prices. Currently, the market is broadly betting on continued monetary tightening. However, if the US-Iran conflict eases and inflation pressures quickly subside, rate hike expectations could also reverse. Historical experience shows that when the pressure from real yields subsides, gold and mining stocks often begin an upward trend. Christopher Wood, global head of equity strategy at Jefferies, stated that if the current boom in artificial intelligence capital expenditure bursts, the Fed will lose the realistic basis for continuing rate hikes. He said, "For all these reasons, after a long period of waiting on the sidelines, investors should now gradually rebuild positions in gold and gold mining stocks. The trade logic based on a weaker US dollar is merely dormant, not gone."
Overall Outlook
Overall, short-term rate hike expectations remain the dominant force suppressing gold prices. However, various bearish factors have been largely digested, and the logic of diversified support for gold has not failed. The focus going forward will be on tracking the evolution of the US-Iran situation, US inflation data, and the shift in real yield expectations. Once the expectation of tightening loosens, the gold and mining sector is set for a recovery rally. In the latest developments, Iran has privately softened its stance on demining. Qatar stated on Tuesday that mediators are making progress in efforts to end the US-Iran conflict. US Treasury Secretary Bessent said a deal could be reached within two days. Brent crude oil futures have plunged nearly 12% over two days, easing inflation concerns and the pressure on the Fed to raise rates. In early Asian trading on Wednesday (August 5), spot gold oscillated higher, briefly breaking above the $4,120 mark. As of 10:47, it hit a two-week high of $4,130.04 per ounce. As of 10:47 Beijing time on August 5, spot gold was trading at $4,128.79 per ounce.
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