Is Debt Driving the Gold Price?

For much of the summer, gold has largely been caught between two forces. First came the war in Iran and the closure of the Strait of Hormuz, pushing oil prices higher and adding to global inflation concerns. Then, increasingly the role of the Federal Reserve played a bigger part, as markets tried to second-guess the direction of US interest rates. Both still matter and are playing a key role in the direction of the gold price. But after a sharp rally over the past fortnight pushed gold back towards levels not seen since May, another factor appears to have taken centre stage: bonds and government debt. And unlike the other drivers, this issue really does play to some of the fundamental factors that historically supporting gold.

These different forces are of course, interconnected. Oil affects inflation, which affects interest rates, that play a role in bond yields and ultimately impacting the cost of servicing America's enormous debt pile. Last week US government debt moved beyond $40 trillion, while higher borrowing costs are making that debt increasingly expensive to service. A debt so high that it is estimated it would take $1.4T to service that it every year, making it the largest single expenditure of the federal government. Given US Treasuries Yields are increasing, with US debt on a course that could see it surge past $50T by 2029, it made last week's announcement and catalyst for the surge in the gold price all the more interesting.

It was announced that from September, the US Treasury will at least double the maximum size of its buybacks of certain longer-dated bonds, increasing them from $2 billion to $4 billion per operation. The Treasury says the move is intended to provide greater liquidity in the long end of the bond market. Some may draw comparisons with quantitative easing because government bonds are being bought back, although there is an important distinction: this is the Treasury managing the liquidity of its debt, not the Federal Reserve creating money to purchase bonds.

Despite the initial reaction to the announcement, longer-term Treasury yields remain stubbornly high. Ordinarily, that should be bad news for gold, because when government bonds offer attractive yields, a non-yielding asset becomes relatively less appealing. There were other reasons why gold should have stumbled last week as well - Flash PMI data on Friday showed continued strength in parts of the US economy, potentially complicating expectations around the Fed's next interest-rate decision. Whilst tensions remain unresolved in Iran with threats continuing to be traded on both sides including the promise of further economic sanctions for Iran.

The fact gold continued to climb and remain elevated, suggests investors may be looking beyond what bond yields are and placing the upmost importance on understanding why they're so high in the first place. America needs to finance an enormous and growing debt pile, which leads to concerns around fiscal sustainability, future monetary policy and ultimately currency debasement, which begins to enter the conversation.

That doesn't prove government debt has suddenly become the only thing that matters, as unfortunately, markets are rarely that considerate. But it does suggest it perhaps is having a leading role currently, especially given its influence and link to some of the fundamental drivers that has given support to gold over the course of history i.e. less trust in the health of the financial system. As an example, gold rose in euros as well as dollars last week, which suggests the move cannot simply be explained away as dollar weakness - potentially pointing towards a broader demand for gold amid fiscal uncertainty.

As we've covered previously, this isn't solely an American story. Debt pressures are being felt across developed economies, while central banks continue to accumulate gold.

The direction of travel is particularly interesting, with Hong Kong Exchanges and Clearing recently reporting record physical gold deliveries linked to its US dollar-denominated gold futures contract. There are also indications that China's official gold purchases may understate its true accumulation, while its holdings of US Treasuries have been moving in the opposite direction. There was also the news last week that South Korea has also returned to the gold market after a lengthy absence.

No single purchase tells us very much. Together, however, they contribute to a much bigger question around why central banks are less comfortable holding another country's debt and more comfortable holding an asset with no counterparty at all. The answer to this leads to a considerably longer-term story than September's interest-rate decision.

Fundamentals may be playing a bigger role, but there's still plenty this week capable of moving gold in either direction.

Markets have another run of US economic releases to digest:

For months, we've been asking whether Iran or interest rates would dictate gold's next move, but increasingly, the answer may simply be debt.



Precious metal prices can be volatile and the value of your metal may go down as well as up. No responsibility can be accepted by Jewellery Quarter Bullion Limited for any loss caused by acting on information we have provided. We do not offer investment or tax advice and recommend that you conduct your own independent research before making any investment decisions.