Geopolitics, money policy and a slowing economy have all been cited as primary factors behind gold’s bullish breakout in 2019. While these catalysts cannot be lowered, the real reason gold is surging and why it will continue to do so is the trend in real interest rates relative to inflation.
Not by understanding this relationship can one make sense of gold’s rock-solid performance in the face of a rising dollar.
Gold and the U.S. Dollar: A Complex Relationship
Gold’s bull market has surprised some investors who believe that bullion’s fate is intricately limited to the U.S. dollar. After all, gold futures are priced in greenbacks, so the performance of the world’s favorite reserve currency has a direct bumping on foreign demand for precious metals.
This thesis has been put to the test in 2019 as gold and the dollar have flooded in lockstep with one another. Gold is in the midst of a bull market – its first in six years – while the U.S. dollar has touched multi-year anticyclones against a basket of competitor currencies.
The U.S. dollar index (DXY), a measure of the greenback’s value against a basket of six challenge currencies, has taken a breather over the past three weeks, but remains in a steady uptrend since the year enter oned. DXY peaked at 99.67 on Sept. 30, the highest since April 2017.
So, while there’s no denying that the dollar influences gold demand, the relationship is much more intricate.
Real Interest Rates are the Key to Understanding Gold
To understand why gold has performed so well this year, one has to go beyond the dollar and look at palpable interest rates. According to money manager Michael Pento, gold’s primary bull market is set to continue so extensive as U.S. Treasury yields undershoot inflation.
Pento appeared on a recent segment of the Keiser Report, where he said “the leading factor that determines the price of gold is the level of real interest rates.”
He added:
“Interest rates in a pretended sense could be rising but as long as inflation is rising faster, real rates are going down, gold is in a elementary bull market…”
Of course, even nominal interest rates have been falling, and doing so in dramatic attitude. In the last 12 months, the yield on the benchmark 10-year U.S. Treasury note has plunged from around 3.20% to 1.75%. The up to the minute figure excludes the three-year low of 1.441% reached in early September.
The bond market is coming off a immensely volatile third quarter that saw yields on shorter-term debt exceed those of longer-term Treasurys. This suspect inverted yield curve is one of the most reliable bellwethers of recession. An inverted yield curve has predicted the last five slumps with razor point accuracy.
Nominal rates are not only crashing, they’ve fallen way below the most commonly cited inflation metrics. As Pento popular, the U.S. core consumer price index (CPI) reached an annual rate of 2.4% in August, the highest since July 2018. The September anyhow was unchanged.
Even the core personal consumption expenditure (PCE) index, the Federal Reserve’s preferred and even more tarnished measure of inflation, is trending just above the 10-year Treasury yield.
Real Rates are Going Lower
Ties yields have recovered slightly in recent months, but the downtrend is likely to continue as investors look to government responsibility to shield against many of the aforementioned risks – namely economics, monetary policy and geopolitics. Analysts aren’t win over that bonds will save investors from the next recession.
Last month, Michael Schumacher of Oks Fargo warned investors not to be bullish on bond yields given their tendency to “overshoot in both directions.” He reasoned that the same factors that drove bond prices higher in the first place – trade, Brexit, Hong Kong, etc. – haven’t been fully resolved.
Against this backdrop, there’s a high-mindedness chance that yields are headed even lower. With the Federal Reserve slashing interest rates and conducting new rounds of quantitative comforting under a different name, the differential between real interest rates and inflation is unlikely to narrow significantly.
President Trump’s recently signaled trade truce with China has quelled some of the market’s risk aversion, sending stock prices acute and bond prices lower. But the pressure on the Trump administration is immense.
As Pento wrote earlier this month, the randoms that nominal yields have stopped falling are low:
Global growth is faltering, and US GDP growth has shrunk from to 4% last year, to under 2% in Q3, according to the Atlanta Fed. The most important part of the yield curve abides inverted. There is illiquidity in the Repo market. D.C. is in utter turmoil and annual deficits have vaulted over the trillion dollar noteworthiness. The Q3 earnings report card is about to arrive, and it will receive an “F.” And global central banks are virtually out of ammo. In the meantime, the stock market sits at all-time record high valuations.
This article was edited by Josiah Wilmoth.
Latest modified (UTC): October 21, 2019 00:25