• The spot gold price has rallied 7.7% since mid-December.
• The Commonwealth Bank is forecasting there’ll be more gains to come in the next couple of years.
• It says the US dollar, rather than real US bond yields, has recently become the main driver of movements in the gold price. It expects that trend will continue.

The spot gold price has been on a nice run since mid-December, adding 7.7% to currently sit at $1,330 an ounce.

The Commonwealth Bank thinks there more gains to come.

“We upgrade our gold price forecast to reflect our weaker US dollar outlook,” says Vivek Dhar, Mining and Energy Commodities Analyst at the Commonwealth Bank.

“The US dollar, which is negatively correlated to gold prices, has only recently become the primary driver of the precious metal.”

As seen in the chart below from Dhar, the relationship between real, inflation-adjusted US 10-year bond yields and the gold price has diverged recently, replaced instead by movements in the greenback.

“The once reliable relationship has broken down in recent months,” says Dhar.

“Typically, rolling correlations do move around over time, but the last time the correlation between US 10 year real yields and gold prices diverged this much was 2012.

“Surprisingly, the US dollar has emerged as the more reliable relationship with gold prices over the last six months.”

And Dhar expects that trend to continue in the medium-term.

“We believe gold prices will move more in line with the US dollar until mid-2019,” he says. “After that we expect the US 10-year real yields to become the primary driver of gold prices.”

As such, Dhar has upgraded his gold price forecasts over the next few years, seeing it rise to $1,361 in 2019 before moderating in the period after.

Dhar says geopolitics creates the largest upside risk to his forecast track, especially the potential for a trade war between China and the US.

“The initial impact on gold prices from the US-China trade war has been positive, which we expect will continue,” he says.

As for the main downside risk, he says it would be for the relationship between gold and real 10-year US yields to reassert itself earlier than he currently expects.

“[The] CBA is anticipating a rate hike in June and September and another rate increase in March and June next year. That would leave the terminal Fed funds rate to plateau at 2.5-2.75%,” he says.

“If the [Fed hikes rates three times this year and next], that will imply more downside pressure on gold prices than if our outlook eventuates.

“However, the impact on gold prices is only relevant if the inverse relationship between gold prices and US 10 year real yields is re-established.”

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