Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold looking for a break as real yields tumble
Ole Hansen
Head of Commodity Strategy
Summary: Gold trades higher, but still within its recently established range, following a big miss on the July ADP Employment report. It has raised a few and potentially gold supportive questions about the current strong growth narrative ahead of Friday's US job report. For now it remains stuck just below resistance at $1835.
Gold trades higher, but still within its recently established range, following a big miss on the July ADP Employment which showed an increase of 330k versus 690k expected. While notoriously volatile it nevertheless has raised a few and potentially gold supportive questions about the current strong growth narrative ahead of Friday’s US job report.
Having just returned from my holiday the first question I had to ask myself was why gold was not trading quite a bit higher. During the past month US Treasury yields have seen steep declines and with inflation expectations not changing much, the inflation adjusted rate or real yield has slumped to a record low at -1.22%. Given the historical strong inverse correlation between real yields and gold, the failure this past month to respond has caused a great deal of head scratching among participants, potentially resulting in some long liquidation for fear that a recovery in yields may not be met the same level of inaction.
So far, however, yields continue to drop and with the Delta coronavirus variant once again causing lockdowns and reduced mobility in major economies such as China and the US, the market may begin to see current low yield levels potentially for longer as economic growth momentum slows and central banks become more cautious about letting the tapering genie out of the bottle. A scenario of lower yields and potentially also a weaker dollar into a slowing growth momentum could see gold once again become attractive as an additional or alternative diversifier to other assets, such as stocks and bonds.
Gold has spent the past few weeks trading within a 40 dollar range between $1795 and $1834, the latter being the 50% retracement of the June correction. A break above could initially see it target $1853 followed by the June high at $1917.
Gold’s recent failure in responding to falling real yields helped trigger renewed selling from funds during the latest reporting week to July 27. Silver meanwhile has witnessed an even greater exodus with the relative underperformance against gold moving the XAUXAG ratio back above 70 ounces of silver to one ounce of gold. As a result hedge funds recently cut their net long to just 21k lots, a 14 month low. A break back below 70 could see silver return to driving seat, thereby supporting gold in its attempt to rekindle its correlation with US real yields.
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