The December gold futures contract fell into the proverbial elevator shaft Wednesday morning with a bloodcurdling $25 drop to $1,260 (U.S.) per ounce in a matter of seconds. This continues a multi-week pattern of weakness in precious metals markets that has seen the gold bullion price fall 3.5 per cent. The news is all the more surprising given that another alternative form of money, Bitcoin, rocketed higher – before inevitably collapsing, of course.
When gold makes a big move, changes in U.S. real interest rates and the U.S. trade weighted dollar are the two usual suspects . This time, real rates are clearly the culprit.
The chart below compares inflation-adjusted 10-year Treasury yields (I used breakevens to adjust) with the gold price. Historically, the gold price has moved in the opposite direction of real interest rates. The logic behind the pattern is that when Treasuries provide yields greater than inflation, they are a more attractive investment option than non-dividend paying bullion.
The slide in gold prices from Nov. 7 has coincided with an 11-point rise in real interest rates to 0.54 per cent. This doesn't sound like much in nominal terms, but it represents a 25-per-cent increase in inflation-adjusted returns.
U.S. Treasury 10-year yield (inflation adjusted) vs Gold spot price (U.S.)
SOURCE: Scott Barlow/Bloomberg
Gold price also tends to move in the opposite direction of the U.S. dollar, but the U.S. trade weighted dollar (DXY) has declined along with the bullion price so we can rule that out as a cause for recent gold price weakness.
Comments from the Federal Reserve will be the key to gold performance from here if current patterns persist. Incoming Fed chairwoman Janet Yellen and Chicago Fed president Charles Evans have recently made dovish noises, suggesting that the taper option is off the table and that the central bank will remain heavily involved in bond markets.
Treasuries sold off as a result (yields rising) on fears that continued monetary intervention will eventually become inflationary. For now, however, breakevens suggest inflation fears are subdued. The combination of rising Treasury yields and stable inflation is increasing real Treasury yields, and driving the gold price lower. In short, gold will continue lower as long as U.S. bond yields climb.
As for Bitcoin, I still can’t figure out why anyone would bet hard-earned investment dollars on a monetary experiment. The alleged virtual currency jumped from $150 in October to briefly hit $900 and continues to look like a lesson in greater fool investing. It has, as far as I can tell, no connection to gold or any fiat currency that can be widely used as a medium of exchange. Bitcoin might be interesting, but its success or failure has nothing to do with the outlook for precious metals prices.
Scott Barlow