For some reason, the effect of bond yields on gold is most visible with the ten-year bond. I’m not sure why, but one theory is that the average time it takes to take a mine from discovery through to production is around ten years, so gold and ten-year bond yields tend to correlate.
But we also noted that gold was oversold, that it was sitting on an important technical level, that we were headed into a positive time of year for gold (April is usually a good month). What’s more, we noted that business was getting back to normal.
Rising yields indicate that people expect economic strength. A strong economy gives rise to inflation. Gold is the de facto hedge against inflation. In the long-term then, rising yields are good for gold.
The bottom-line roadmap was that we expected a rally in April, a turn in May, a June low and then highs later in the year.
We got the April rally: gold went from $1,680 to $1,845 a couple of days ago. It now sits ten bucks lower. Are we now getting the May turn? It’s possible, but the landscape has changed.
There are two big changes in the underlying drivers. Firstly, bond yields have turned down. Inflation expectations, meanwhile, have risen again. As Charlie Morris notes in The Fleet Street Letter this week: “If the reduction in the bond yield continues, then markets will start to favour more defensive assets. This would be a major shift in the narrative that has built up over the past year, from value back to gold”.
Morris has recommended that his readers, already long gold, buy more. He thinks we are headed back into a “risk-off” environment, and you want to be in safe assets.
Perhaps the biggest driver of the lot though is the US dollar itself. The mini bull market it enjoyed in the first three months of the year that saw the US dollar index go from 89 to 93 is well and truly over. It is now back at 90, almost where it started.
Let’s pull back and look at the bigger picture. When we do this, the first three months of 2021 just look like a counter-trend rally in a US dollar bear market, one that began with the Covid-19 panic of March 2020 at 104.
Below is a ten-year chart. I’ve marked the March 2020 top, which coincides with the 2017 highs, and the current broader trend both in blue.
If this bear market breaks below 88, it will go to the low 80s and gold will go a lot higher. By a lot higher, I mean over $2,000 an ounce, and to record highs.
As so often seems to be the case, the fate of gold will be the fate of the US dollar.
So the questions we have to ask ourselves are: “whither ten-year bond yields?” and “whither the US dollar?” Whither, by the way, is olde English for “to what place” – a very useful word that I am surprised we don’t use more often. Nevertheless, we are doing what we can to revive it here on these pages.
I’m less sure about bond yields, but I do know the powers-that-be will not let them rise too high. My hunch is that the all-important US dollar goes lower. That will be good for gold, but there is a lot of support in the 88-89 region to get through first.
Over the last ten years late May has consistently been the best time of year to buy gold. But over the last 40 years July has been the time. So gold does tend to be weak in the early summer.
We’ve had a nice run. I rather suspect a period of range trading while the US dollar plays with that 88-89 area. The next big run will come when that support is broken.
So, if you are not long gold and you are thinking of taking a position, I’d recommend looking for dips over the next couple of months.