The gold bull market is not over yet: UBS says three major structural forces are still driving up gold prices

　　Source: Jinshi Data

　　From 1834 to 1971, the value of the US dollar was defined by a fixed amount of gold. After the collapse of the Bretton Woods system in 1971, gold entered a free trading era and experienced three major bull markets: 1971–1980, 1999–2011, and from 2018 to the present.

　　UBS believes that the current gold uptrend that began in 2018 is still ongoing. The previous two cycles corresponded to the reconstruction of the monetary order and the financialization of gold, respectively. While this cycle has also been driven by factors such as declining real interest rates and quantitative easing during the pandemic, the basis for gold pricing has already changed.

　　Russian reserves frozen, gold pricing logic rewritten

　　The first major gold bull market in the 1970s lasted about eight and a half years, with an annualized gain of 46%, making it one of the most dramatic asset revaluations in modern history. At that time, the breakdown of the postwar monetary system, deeply negative real interest rates, rising geopolitical risks, and expanding fiscal deficits jointly led to a repricing of the gold price.

　　The second bull market lasted even longer, with an annualized gain close to 18%. During this period, gold became increasingly financialized, while also benefiting from Chinese demand, rising commodity prices, and the Federal Reserve’s extremely loose monetary policy.

　　Since the third bull market began in 2018, the annualized return has reached 19%. However, the critical change shaping this cycle is not just interest rates and liquidity.

　　Global reserve managers then had to reconsider one question: If $630 billion held in US Treasuries, German Bunds, UK Gilts, and other bonds could become inaccessible overnight, what assets could truly serve as reserve assets?

　　Gold has become one such answer. The share of gold as a proportion of reserves held by emerging market central banks and sovereign funds has risen from 5–7% in 2022 to 11% now, though this is still well below the 26% level of developed market peers.

　　This allocation gap means that

　　Real interest rates rise, but gold doesn’t decline as before

　　From March 2022 to October 2023, the 5-year US real yield rose by more than 4 percentage points in total. According to the historic relationship of the past 20 years, the gold price should theoretically have declined by about 55%, but in reality, gold rose by 7% instead.

　　In the next two years, the US real yield fell by less than 1 percentage point, yet gold soared by 110%.

　　This indicates that gold’s sensitivity to changes in real interest rates has become markedly asymmetric:

　　Traditional fair value models have thus found it increasingly difficult to explain current gold prices. UBS points out that many models even view gold as significantly overvalued when it trades above $2,500/oz, but these models ignore two other important variables.

　　One is the changing correlation between stocks and bonds.

　　In the inflationary cycle of the past five years, bonds have often failed to effectively hedge equity risk. Gold has instead become a more effective diversification tool for portfolios heavily weighted in stocks.

　　According to the World Gold Council, the proportion of financial assets allocated to gold by individuals and institutions is currently just 3%, leaving considerable room for increased allocation.

　　If in the future, inflation and inflation volatility fall back down, the stock-bond correlation may resume its negative value. At that point, investors may return to favoring yield-generating bonds over gold as a diversifying asset.

　　But UBS judges that we have not yet entered this stage.

　　US fiscal pressures are becoming a new variable in gold pricing

　　Another long-term driving force comes from the persistent erosion of confidence in US public finances.

　　UBS measures this by the term premium—i.e., the extra return investors demand for holding long-term bonds instead of short-term debt. As the term premium rises, it is also becoming an important determinant of gold prices.

　　US public debt has now surpassed $40 trillion and could increase by a similar amount over the next decade. At the same time, the US government is strongly hoping to avoid the most direct market consequence of this fiscal situation: persistently rising long-term Treasury yields.

　　With the economy at full employment and the fiscal deficit around 6% of GDP, how can long-term yields be suppressed?

　　The US is already showing