Stable demand, evolving drivers Gold has long been seen as a hedge against inflation, currency debasement, and systemic risk. Despite the recent correction, its performance in the last year has been nothing short of remarkable, having risen 50% at the time of writing. This surge has materially outperformed most other asset classes and attracted strong investor inflows. While many have examined the drivers behind this rally, we were drawn to study how its catalysts have evolved over time.

A commonly highlighted point is the strength of central bank buying. Official sector purchases have been both robust and persistent, providing a stable source of structural demand. While this helps underpin prices, it does not fully explain the magnitude and persistence of the recent rally. Central bank buying tends to be gradual, price-insensitive, and relatively predictable, characteristics that support valuation but rarely drive sharp price appreciation on their own. The scale and speed of gold’s recent gains therefore suggest that additional, more dynamic forces are at play.

Pedal to the metal

Historically, gold prices have been highly sensitive to changes in real yields. When real yields rise, investors typically rotate out of non-yielding assets like gold and into income-generating securities. This relationship is both intuitive and empirically robust. Between 1990 and 2021, a simple linear regression using monthly data shows that the 10-year US Treasury real yield explains around 85% of the variation in spot gold prices. This implies roughly a 3% decline in gold prices for every 1 basis point (bp) increase in 10-year real yields.

However, things can change quickly. Since 2022, this historically stable relationship has broken down. Gold prices have proven far more resilient than the historical regression would suggest. The beta has flipped positive, while the R-squared has declined sharply from 85% to just 16%, indicating a near-complete loss of explanatory power.

Several explanations have emerged. These include heightened geopolitical risk following the Russia–Ukraine conflict, persistently elevated inflation, changes in central bank demand, concerns over fiscal sustainability, episodes of dollar weakness, and renewed questions around central bank independence. While diverse, they share a common thread: they reflect a growing sense of structural uncertainty and investor unease.

Enter term premia

To better understand this shift, we sought to identify a more robust quantitative framework. Using “investor pessimism” as our initial line of inquiry delivered something of a fortuitous outcome. By repeating our earlier regression analysis using the 10-year government bond term premia as the independent variable returned similar results, with the relationship reverting positive across the US, Eurozone, UK and Japan, but with a far stronger R-squared than in the previous regression.

This suggests that gold is increasingly reacting not to the level of real rates per se, but to the compensation investors demand for holding long-duration government bonds. In other words, gold appears to be responding to concerns around fiscal credibility, policy uncertainty, and long-term macro risks.

This evolution becomes even clearer when examining rolling three-year correlations between gold and term premia:

• Notably, for much of the period from 2002 to 2020, their relationship was generally negative. This means that, during and after major recessionary periods, the two tended to move in opposite directions, reflecting gold’s traditional role as a hedge.

• However, the rise in correlation observed since 2020 suggests a regime shift, indicating that markets are increasingly viewing both gold and long-term bond risk premia as reflecting similar underlying concerns, namely, persistent structural risks related to fiscal policy, rising government debt burdens, and potential erosion of central bank credibility.

What is gold’s reaction function again?

To complete the analysis, we examined gold’s returns under simultaneous changes in the 10-year US Treasury real yield and term premium, splitting the sample into pre- and post-2022 periods and visualising the results using bivariate density (KDE) plots. As you can see:

• Until 2021 (left-hand blue chart): Gold’s reactions were relatively predictable, with outcomes concentrated in a defined quadrant, reflecting how the strong relationship with real yields was offset by the weak link to the term premium.

• From 2022 onward (right-hand yellow chart): Gold’s responses have become far more dispersed. The distribution shows a clear rightward skew, indicating that gold is rising across a wider range of macro conditions than previously observed. This suggests a breakdown of its traditional reaction function and highlights the growing importance of less quantifiable drivers.

To Wrap Up

Given these findings and the more nuanced outlook, we conclude that gold is a less straightforward addition to fixed income portfolios in today’s regime. While it may still offer protection against certain tail risks, an evolving correlation structure makes gold’s diversification benefits less predictable and potentially less reliable.

Importantly, the recent rally cannot be attributed to a single factor such as central bank demand. Instead, we think it reflects a broader repricing of structural risks, including fiscal sustainability, policy credibility, and long-term macro uncertainty. This shift has altered gold’s behaviour in ways that also challenge its traditional role within portfolios.

Investors should consider moving beyond legacy frameworks and carefully reassess the specific risks they aim to hedge. In a world where gold is increasingly driven by complex and overlapping forces, its role within fixed income portfolios is likely to remain more fluid and less dependable than in previous cycles.

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