Gold : Bullish Breakout
(Fri, 26 Jun 2020). After reaching fresh yearly highs earlier this week, the gold price bullish breakout may be facing its first test of fortitude: a return back to its former consolidation’s resistance. Given the outlook for real yields and gold price’s historical relationship with volatility, the fundamental bias remains bullish for precious metals.
GOLD PRICES EDGING HIGHER
Gold prices have slowly but surely climbed higher, overcoming resistance earlier this week to breakout to fresh yearly highs. The bullish breakout potential for gold prices has been on our radar for several weeks, given the technical posture of price action in recent months coupled with what has been an increasingly strong fundamental backdrop.
And the fundamental backdrop remains strong, if not strengthening. Increased trade tensions between the US and China have not gone unnoticed, threatening to undermine an already fragile global growth environment. Coupled with signs of increased positive test case rates and hospitalizations rates in the United States (there can’t be a second wave if you don’t beat the first wave), concerns have set in that the coronavirus pandemic will have real staying power over the coming years.
Commentary previously issued on the matter remains valid: “the backdrop of increasing macro uncertainty caters to one of the talking points from the Federal Reserve’s June policy meeting…which was that interest rates would be staying at current levels for the foreseeable future, perhaps through 2022. Fresh signs that the global economy’s two largest economies, the United States and China, are not ready to re-open and begin the path to normalcy has provoked another reach for safe havens.”
WHY DO ‘REAL YIELDS’ MATTER TO GOLD PRICES?
Increasing risk aversion, noted by the continued weakness in US Treasury yields following the June Fed meeting, highlight one of the most important fundamental underpinnings of precious metals’ rallies: environments that produce falling real yields tend to be the most bullish (particularly for gold prices).
Real yields are inflation-adjusted yields: in this case, the US Treasury 10-year yield minus the headline inflation rate. Why should market participants care? Both trading and investing are about asset allocation and risk-adjusted returns: they’re about achieving specified required returns given the trader’s or investor’s wants and needs.
If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing, ergo, higher inflation? On a real basis, your returns would be lower than otherwise intended.
Falling US real yields means that the spread between Treasury yields and inflation rates is decreasing. If precious metals yield nothing (no dividends, coupons, or cash flows), they would be in a more favorable position to hold, relatively speaking, when US real yields fell.
GOLD VOLATILITY CONTINUES TO DROP
Gold prices have a relationship with volatility unlike other asset classes, even including precious metals like silver which have more significant economic uses. While other asset classes like bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – gold tends to benefit during periods of higher volatility.
Heightened uncertainty in financial markets due to increasing macroeconomic tensions increases the safe haven appeal of gold. Now that there are plenty of signs that no V-shaped economic recovery will occur, and the Federal Reserve intent on keeping the liquidity spigot open for the foreseeable future, the winds of an inflationary US economic environment are blowing through financial markets.
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