Glittering returns: Gold outshines equities in a falling-rate environment

Asset prices rally as US bond yields plunge, signalling a global rate reversal

Gold has been a bigger beneficiary of the reversal in the global interest cycle compared to equities. Gold prices in the international market are up 60 per cent in the past two years, compared to a 47.3 per cent rise in the S&P 500 index and a 28.5 per cent rise in the Dow Jones Industrial Average during the same period. The S&P BSE Sensex is up 39.8 per cent during this time.

The yellow metal has also outperformed equities in the 2024 calendar year so far. Gold prices are up 26.8 per cent year-to-date (YTD), compared to a 19.6 per cent rise in global equities since the start of the year, while the Indian equity benchmark has rallied 17.1 per cent in the same period. The 30-stock Dow Jones has lagged behind its peers, rising just 11.6 per cent YTD.

The rally in asset prices comes in the backdrop of a sharp decline in bond yields in the US, signalling a reversal in the global interest rate cycle. The yield on the benchmark 10-year US government bond peaked in October last year and has since fallen by around 120 basis points (bps). The yield on US 10-year Treasury bonds settled at 3.74 per cent on Monday, down from 4.93 per cent at the end of October 2023. The benchmark bond yield has declined by 14 bps YTD, from 3.88 per cent at the end of December 2023.

Similarly, the yield on the 10-year Government of India bond has dropped by around 50 bps over the past year and nearly 30 bps YTD.

The US Federal Reserve (Fed) confirmed the reversal in the global interest rate cycle when it cut its policy rate by 50 bps last week — its first rate cut in four years. Earlier, the European Central Bank reduced its policy rate by 25 bps in a bid to spur economic growth.

Rate cuts by the world’s major central banks and a general decline in bond yields have boosted asset prices, including equities and precious metals.

A decline in interest rates lowers the opportunity cost of holding gold, as it is a non-income-bearing asset, unlike bonds that provide a yield or interest to the holder.

Goldman Sachs Research sees further upside in gold prices from current levels, driven by a rate cut by the Fed and gold purchases by major emerging market central banks.

“Gold offers significant value as a portfolio hedge against developments such as tariffs, Fed subordination risk (i.e., the risk that its independence may be undermined), and debt sustainability fears. We see roughly 15 per cent upside in gold prices under a rise in (US) financial sanctions, with similar gains if mounting debt concerns spur US government credit-default swap spreads to widen by one standard deviation (13 bps),” write Goldman Sachs Research strategists Samantha Dart and Lina Thomassee in a report published earlier this month.

According to data from Goldman Sachs Research, the net purchase of gold by central banks increased to an average of 310 tonnes per quarter from July 2022 to March 2024, up from a quarterly average net purchase of 119 tonnes from January 2010 to June 2022. The increase in net purchases by central banks was largely spurred by the Russia-Ukraine war and the resulting US financial and economic sanctions on Russia.

According to analysts at JP Morgan, rising geopolitical tensions are now a bigger driver of gold prices than economic factors such as interest rates and the dollar index.