Three Charts That Explain What’s Happening With Gold Prices | WSJ

Key Concepts

• Gold Futures: Contracts to buy or sell gold at a predetermined price at a specific time in the future.
• Troy Ounce: A unit of measure for precious metals, equal to approximately 31.1035 grams.
• Inflationary Shock: A sudden and significant increase in the general price level of goods and services.
• Policy Dysfunction: A state where government policies are ineffective or contradictory, leading to instability.
• Runaway Deficits: Government spending exceeding revenue by a large and increasing margin.
• Reserve Assets: Assets held by central banks to support their financial systems and manage currency stability, often including foreign currencies and gold.
• US Dollar Depreciation: A decrease in the value of the US dollar relative to other currencies.
• Interest Rate Cuts: A reduction in the benchmark interest rate set by a central bank, typically to stimulate economic activity.

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The Unprecedented Gold Rally: Drivers and Dynamics

The price of gold has reached an unprecedented $4,000 a troy ounce, marking its highest level ever. This rally is described as unusual, surpassing any seen since at least 1979. Historically, investors turn to gold during times of economic uncertainty because it tends to retain its value and acts as a hedge against inflation, maintaining purchasing power when the dollar depreciates.

Historical Context and Current Uniqueness: Previous significant gold run-ups were linked to financial meltdowns:

• 1979: An "inflationary shock" prompted investors to flock to gold.
• 2020: The global pandemic significantly disrupted economic expectations.

The current rally, however, presents a different scenario. It occurs amidst a record-setting "AI craze stock market" on one hand, and significant concerns about "policy dysfunction in Washington" on the other. These concerns include "runaway deficits," the threat of a "government shutdown," and an apparent lack of concern for higher inflation in the US economy, exemplified by President Trump's push for lower interest rates.

Timeline of the Current Rally: Gold prices initially surged during the first part of Trump's second term. A period of stagnation followed over the summer until August, when Federal Reserve Chair Jerome Powell delivered a speech. Powell signaled that the Central Bank would begin "cutting interest rates despite above target inflation," stating, "The baseline outlook and the shifting balance of risks may warrant adjusting our policy stance." Since this announcement, gold prices have accelerated significantly.

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Central Bank Gold Accumulation

A major factor supporting the gold rally is the substantial increase in gold reserves by central banks worldwide. Since the Great Financial Crisis, central banks have been "snapping up gold bullion." This accumulation is driven by "a lot of doubts of the global financial system," which is deeply interconnected with the US economy, US banks, and the US Federal Reserve.

For decades, the US dollar has been the most common "reserve asset," serving as the de facto "gold standard" for these reserves. However, central banks are now continuing to buy gold, and many major Wall Street banks anticipate this trend will persist into the next year, providing ongoing support for gold prices.

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US Dollar Performance and Economic Outlook

The performance of the US dollar over the past year has been notably weak. By one measure, the US dollar experienced its "weakest first half in the last 50 years." The Trump administration, in some respects, desires a weaker US dollar as it benefits US exporters by making their products more competitive abroad.

However, additional factors have contributed to the dollar's depreciation against other currencies:

• Lack of Confidence: A pervasive lack of confidence in the outlook for the US economy, which became particularly evident around the "Liberation Day tariffs in April," creating significant uncertainty regarding the US economy and inflation.
• Long-Term Deficits: Following the passage of "Trump's Big Beautiful Bill" through Congress, there have been mounting concerns about long-term deficits in the United States and how the government plans to finance them through debt.

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Potential Risks and Counterarguments

Despite the current vertical surge in gold prices, some investors are exercising caution, recalling historical patterns. The 1979 gold boom, for instance, saw "a lot of the real price gains in gold evaporated within the next couple of years."

Skeptics suggest that several factors could exert "negative downside pressure on gold prices":

• If US institutions demonstrate resilience.
• If the Federal Reserve maintains its independence.
• If inflation successfully comes down.
• If US economic growth continues.

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Synthesis and Conclusion

The current gold rally to $4,000 a troy ounce is a complex phenomenon driven by a confluence of factors: investor flight to safety amidst unique economic and political uncertainties, aggressive gold accumulation by central banks questioning the stability of the global financial system, and a weakening US dollar influenced by policy concerns and deficit worries. While the immediate outlook for gold appears strong, historical precedents and potential improvements in US economic fundamentals or policy stability suggest that the rally may face headwinds, prompting some investors to temper their enthusiasm. The interplay of these forces creates a dynamic and uncertain environment for gold's future trajectory.