Macro: Sandcastle economics
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Gold: Surging real yields battle stagflation risks for supremacy
Ole Hansen
Head of Commodity Strategy
Summary: Gold remains rangebound after Monday's drop, the biggest in three months, with surging US treasury yields and the market now pricing in two consecutive 75 basis point rate hikes being the latest developments challenging gold's ability to protect investors against surging inflation. The successful or unsuccessful race to combat inflation before the economy begins to suffer has become a major theme and one that will determine the ultimate direction of gold.
Gold’s response to Friday’s stronger than expected US inflation print and tumbling consumer sentiment highlights the mixed focus that has kept bullion range bound for a while now. All year, gold has been battling rising treasury yields while at the same time finding support from investors looking for protection against inflation, stock market and geo-political risks. This battle culminated on Monday when traders spooked by the higher-than-expected inflation started to force the hand of the US FOMC by pricing in two consecutive rate hikes of 75 basis points.
The FOMC meets on Wednesday, just weeks after Fed Chair Powell poured cold water on the idea, the FOMC would step up its pace of rate hikes above 50 basis points, but the shared view that the central bank is getting behind the curve has forced a sharp repricing of yields and rate hike expectations, while also bringing forward the timing of a US recession.
Since Friday, US two-year yields has spiked higher by a record 0.54%, reaching a 15-year high at 3.35% while ten-year real yields, a much-used gauge for the direction of gold has spiked higher to reach 0.65% a level last seen in March 2019 and up from -1% at the start of the year. Based on the historic relationship between gold and real yields, some will argue that gold is currently overpriced by more than 300 dollars.
Against this significant headwind we are also increasingly seeing the risk of a hard landing meaning that a US recession could emerge before inflation is being brought under control, thereby creating a period of stagflation, periods which historically has been bullish for gold. As Ben Carlson, an author of finance books and market commentator somewhat jokingly wrote on Twitter: “The Fed needs to raise rates as quickly as possible to tame inflation by sending us into a recession where they can then cut rates to save us from the recession.”
We believe that hedges in gold against the rising risk of stagflation together with traders responding to the highest level of inflation in 40 years, as well as turmoil in stocks and cryptos, are some of the reasons why gold has not fallen at the pace dictated by rising real yields. With that in mind we are watching what investors do, not what they are saying, through the ETF flows. During the past month when gold traded between $1787 and $1878, total holdings in bullion-backed ETFs have held steady within a narrow 13 tons range around 3,265 tons. Any major (negative) change is needed for us to reduce our long-held bullish view on gold, and with that also silver.
From a technical perspective the short-term outlook remains challenged, leading our technical analyst Kim Cramer to provide this comment for our update: “Monday morning buyers tried to lift spot gold spot higher, but sellers quickly took control. The heavy selling pushed the precious metal back below the 200-day SMA (Simple Moving Average) and formed a bearish engulfing candle, a development which demonstrates that sellers are currently in control. That picture is supported by RSI (Relative Strength Index) showing bearish sentiment indicating a rising risk that key support at $1,780 is likely to be tested.
Weekly chart shows that if $1,780 support is broken there is no strong support before around $1,670, and in order to reverse the bearish picture a daily close above $1,880 is needed.”
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