This document discusses recent movements in the gold market and factors that influence gold prices. It covers Jerome Powell's comments at the Jackson Hole meeting that caused assets like gold to rally. It also examines the divergence between rising inflation and falling bond yields in 2021. This bond conundrum could be explained by transitory inflation expectations or slowing economic growth prospects. The environment of low yields and negative real interest rates has been positive for gold, but rising real rates in the future as the Fed tightens could push gold prices lower. However, higher rates may also sow the seeds for a debt crisis or recession further out, which would be bullish for gold.
2. Points To Be Covered Today:
• Gold Follow Through The Strong Bottom
• Gold Prices Produced A Bottom
• Powerful Magnets Of Gold Market
• Bond Conundrum: Boom Or Bust For Gold
• Gold Likes The Environment Of Low Yields
• A Dream Environment For Gold
• Increase Real Interest Rates Push Gold Prices
3. Gold Follow Through The Strong
Bottom
• Jerome Powell’s dovish actions at the Jackson
Hole meeting of central bankers regarding the
upcoming taper and instead discussing why
inflation is transitory caused everything to
roar except the $US and US yields.
Equities, cryptocurrency, energy, and even the
battered gold and silver rallied hard into
Friday’s close.
4. Gold Prices Produced A Bottom
• On the 7th of August, gold prices
produced a bottom on our defined short
term cycles and reversed higher from the
inflection point of 1680.
• We’ve been talking about important
levels like 1680, 1725, and 1765 for the
last few months.
5. Powerful Magnets Of Gold Market
• These levels have proven to be powerful
magnets in the gold market and still
remain the major supports.
• A quick reversal from the 1680 inflection
point means a lot of things, which we’ll
go over in today’s report.
6. Our Thoughts Remain Unchanged
• Despite the fact that the US dollar market was
showing bullish momentum, we have been
bearish in US dollars.
• We haven’t changed our minds about the US
dollar and remain very bearish in the medium
to long term.
• However, we anticipate the US dollar
churning at strong long-term support before
the next leg south.
7. US Dollars For The Last Few Weeks
• This is what is happening in US dollars for the last few
weeks, and the index is simply producing a broad
sideways range.
• We continue to believe that the US dollar’s wide ranges
and high volatility will resolve to the downside in the
near future.
• The huge volatility in US dollar has effected the forex
market which shows that summer doldrums are in.
• Once US dollar resolve its primary trend to downside,
forex markets will likely follow the course.
8. Bond Conundrum: Boom Or Bust For
Gold
• Inflation has risen, but bond yields have declined.
Such a divergence is strange – beware gold bulls!
• Would you like to see something mysterious? If
yes, please look at the chart below.
• It shows the yields on 10-year US Treasuries (red
line) and CPI annual inflation rates (blue line) in
recent years.
• As you can see, a huge divergence emerged this
year: while inflation surged above 5%, nominal
bond yields declined from 1.6% to 1.3%.
9. 10 Year US Treasury Yield & CPI
Inflation Rates In 2021
10. Price Of Bonds & Yields
• Why is it so strange? Well, economic theory
says that when inflation goes up, it erodes the
purchasing power of bonds’ coupon
payments.
• Thus, the price of bonds declines, and yields
increase.
• In other words, when inflation accelerates,
investors demand higher inflation premium to
protect their real returns.
11. Investors & Bonds
• But now we can observe rising inflation and
declining bond yields at the same time.
• The yield on the 10-year Treasury is 1.3%,
which is 4 percentage points below the
inflation rate, so investors who buy bonds lose
a lot of money in real terms. Something is
clearly wrong here.
• Let’s solve this bond conundrum!
12. Investors Trust & High Inflation
• The first potential explanation is that bond
investors trust the Fed and believe that high
inflation is mainly transitory.
• If so, the bond yields are more or less accurate
and could stay around current low levels, and the
inflation rates will adjust.
• The supply disruptions caused by the pandemic
will eventually resolve, while the Fed is going to
tighten its monetary policy, adding to
disinflationary forces.
13. Gold Likes The Environment Of Low
Yields
• At first glance, the scenario in which
inflation is declining seems to be negative
for the yellow metal, as it implies lower
demand for gold as an inflation hedge.
• However, in this case, interest rates could
stay at very low levels for a long time.
And gold likes the environment of low
yields.
14. The Pace Of GDP Growth
• The second possible reason for the decline in interest
rates is that bond investors expect slower economic
growth than previously thought.
• Indeed, recent data suggests that the pace of GDP
growth could be peaking.
• The spread of the delta variant of the coronavirus,
smaller infrastructure plan than initially outlined, a
slowdown in China’s economic growth and the Fed’s
tightening cycle – all these factors could soften the US
growth prospects, translating into lower yields.
15. A Dream Environment For Gold
• It goes without saying that this scenario would be very
positive for gold prices.
• High inflation plus a slowdown in economic growth
equals stagflation, a dream environment for gold.
• However, the stock market didn’t weaken, as one could
expect after a downward revision of investors’ growth
prospects.
• On the other hand, the spread between yields on 10-
year and 2-year Treasuries has narrowed substantially
since March, as the chart below shows.
• The flattening of the yield curve often indicates a
slowdown in economic growth.
16. Functioning Of The Bond Market
• But it’s also possible that technical factors or the
central bank’s interventions trumped the
fundamentals.
• Strong demand for the US Treasuries that pushed
yields down despite rising inflation could be the
case here.
• After all, the Fed has been purchasing $80 billion
a month in Treasuries (and $40 billion in
mortgage-backed bonds) since June 2020.
• In other words, quantitative easing could disrupt
the functioning of the bond market.
17. Interest Rates & Abundant Liquidity
• Indeed, the unprecedentedly easy monetary policy
conditions with ultra-low interest rates and
abundant liquidity could explain why both stock and
bond prices are so high right now (and bond yields so
low).
• In an environment of negative real interest rates
created by Powell and his colleagues, asset managers
search for yield in every possible asset, even if it is not
economically viable – including cryptocurrencies that
are just memes (like Dogecoin) or bonds with yields
lower than inflation rates.
18. What Does It All Imply For The Gold
Market
• Well, I have good and bad news.
• So, the bad news is that the real interest rates
seem to be excessively low (see the chart below)
and they are likely to move up over the economic
expansion (especially when the Fed tightens its
monetary stance), whereas inflation expectations
could ease somewhat later this year.
• Unfortunately for gold bulls, the increase in the
real interest rates would likely push gold prices
lower.
19. What Does It All Imply For The Gold
Market - I
• The good news is that that an increase in interest rates
would put the governments and other debtors in a very
difficult position, potentially leading to a debt crisis.
• Asset valuations could decline and financial crisis could
follow suit.
• In other words, the Fed’s tightening cycle could sow the
seeds of another recession and rally in gold.
• Having said that, we have just recovered from one
economic crisis, and it will take some time for another to
unfold.
• Until that happens, real interest rates may normalize
somewhat without entailing substantial
perturbations, which would be negative for gold prices.
