Outside the Box: 5 reasons why 2019 has been gold’s time to glitter
June was a good month for gold, which made for a strong first-half of the year for the precious metal.
The price of gold GCQ19, -1.19% rose 10% from $ 1,280.30 per ounce at the end of 2018 to $ 1,409.00 at the end of last week. Gold jumped 9% in June (Fig. 1). It finished the month at its second-highest level since May 2013, but still 26% below its record high of $ 1,895.00 in September 2011.
Gold has also rallied strongly so far this year relative to the euro EURUSD, -0.2111% (10%), British pound GBPUSD, -0.2521% (9%), and Japanese yen USDJPY, +0.42% (8%). So not surprisingly, gold is up 9% so far this year relative to the trade-weighted U.S. dollar DXY, +0.34% (Fig. 2). On the other hand, it hasn’t outperformed the S&P 500 SPX, +0.58% , which is up 17.3% so far this year, and 6.9% in June (Fig. 3).
Why has this been gold’s year? And what happened in June? The solid performances of both gold and the S&P 500 during June and so far this year probably reflect the pivots by both Fed Chairman Jerome Powell and European Central Bank (ECB) President Mario Draghi away from monetary normalization, with recent hints that they are considering going back to ultra-easy monetary policies.
The Fed chairman moved in that direction in a June 4 speech, while the ECB president did the same on June 18. Their comments drove interest rates down, with 10-year government bond yields falling around the world. In the U.S., the 10-year Treasury note TMUBMUSD10Y, +1.16% yield fell to 2.0% at the end of last week, the lowest since November 2016, while comparable German and Japanese yields fell deeper into record-low negative territory at -0.33% and -0.13%, respectively (Fig. 4).
The lower bond yield in the U.S. is bullish for gold, particularly since it has been led lower by a significant drop in the 10-year Treasury TIPS yield. Lower bond yields are also bullish for the stock market as they boost valuation multiples, provided that they don’t foreshadow a recession. Consider this:
1. There’s no inflation to hedge against with gold: The yield on the 10-year U.S. Treasury note was at 2.0% on Friday, down from 3.24% on November 8, 2018 (Fig. 5). Over this same period, the comparable TIPS yield is down 86 basis points to 0.31%, one of the lowest rates since September 2017.
The spread between these two yields over that period is down 38 basis points to 1.69% (Fig. 6). This spread is widely considered to be a proxy for the fixed-income market’s outlook for the annual inflation rate over the next 10 years, so its narrowness suggests inflationary expectations remain low. If that’s the case, then why would the gold price be as strong as it is? After all, gold is widely viewed as a hedge against inflation.
Except there’s no inflation to worry about. Indeed, on Friday, we learned that the headline and core PCED inflation rates were just 1.5% and 1.6% year-over-year through May (Fig. 7). The core rate hit the Fed’s 2.0% target only six times since it was publicly set by the Fed at the start of 2012
2. Gold is getting TIPsy: The answer to why gold is rallying can be found in the fact that the gold price tends to be highly correlated with the inverse of the 10-year TIPS yield (Fig. 8). In other words, gold does best when the TIPS yield is falling. That makes sense, since both speculators and investors in gold have to pay for storing the metal somewhere. If the inflation-adjusted financing cost is going down, gold is cheaper to store.
3. Gold diverging from other commodities: In the past, I have often observed that the price of gold seems to confirm the underlying trend in the CRB raw industrials spot price index as well as its basic metals component (Fig. 9 and Fig. 10). However, the price of gold has been diverging from both of these indexes so far this year.
That’s an odd divergence. Is gold signaling that other commodity prices will soon be heading higher? That seems unlikely given the persistent weakness of the global economy. On the other hand, if the U.S. and China strike a trade deal, there could be a “peace dividend” for the global economy, which would boost global growth. In this scenario, the price of gold is likely to move lower.
4. Copper-to-gold ratio coincides with bond yield: While the TIPS yield seems to drive the price of gold, it is interesting to see that the ratio of the price of copper to the price of gold has been highly correlated with the nominal 10-year U.S. Treasury yield (Fig. 11). The same can be said about the ratio of the CRB raw industrials spot price index to the price of gold versus the bond yield (Fig. 12).
This makes lots of sense, though causality runs both ways: A weaker (stronger) copper price signals a bullish (bearish) environment for the bond price leading to lower yields. A lower (higher) bond yield, led by the TIPS yield, tends to be bullish (bearish) for the gold price.
5. Gold is a hedge against economic and political instability: Gold is no longer an inflation hedge because inflation is no longer a problem. Instead, gold might be a hedge against weak economic growth. Why would weak growth be bullish for gold? Economic weakness tends to inflame destabilizing anti-globalization nationalistic political forces around the world; gold is a refuge from economic and political instability.
Ed Yardeni is president of Yardeni Research, Inc. Institutional investors may sign-up here for a trial to his research service. He is the author of Predicting the Markets.
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