The yield curve has recently begun to steepen somewhat after a steady flattening move since mid-July.

In looking at this chart, it would appear that the spread between the 10-year and the 2-year Treasury had simply become too tight (narrow). It had fallen to levels not seen since August of last year!

Surely the Trump Administration’s policies are more conducive to improving US economic growth prospects than those of the business-hostile Obama administration – at least that is what bond traders seem to have finally realized.

Remember – the general rule that has been established between gold and the yield curve – at least for now – is that gold moves INVERSELY to the spread between the longer-dated Treasuries and the shorter-dated Treasuries.

A steepening yield curve ( widening spread) works to depress the price of gold while a flattening yield curve ( narrowing spread) leads to gold buying and an increase in its price.

The reason is relatively easy to understand – traders are looking at the curve as an indication of US economic growth prospects. If the curve steepens out, it signifies that traders believe prospects for increasing growth are good. This in turn will allow the Fed to hike rates at a quicker pace and work to normalize yields which in turn tends to support the US Dollar. The stronger the Dollar becomes, the more difficult for gold to move higher.

The opposite is true if the curve is flattening/narrowing – traders believe US growth prospects would then be diminishing leading the Fed to postpone further rate hikes and keeping yields lower for longer. That in turn tends to undercut the US Dollar and brings buying into gold.

I want to repeat here once more – those who advocate blindly buying gold for inflation protection are missing the point – they seem to forget that it is not rising inflation in and of itself that benefits gold. Quite the contrary – rising inflation, IF it is deemed by the markets to be benign, has a deleterious effect upon gold for the reason that gold does not pay interest. Thus it competes directly with Treasuries.

If the Fed raises rates and the market moves to push longer-dated yields higher, investors looking for yield can purchase bonds/notes provided that they believe inflation pressures will be moderate and remain relatively subdued.We are talking about REAL RATES.

If is only if the markets believe that the Central Bank is behind the 8-ball in dealing with inflation by raising rates too slowly and thus allowing inflation to get out of control, that gold will benefit. This scenario involves what we deem as NEGATIVE REAL RATES – inflation higher than the yield on corresponding Treasuries.

Thus, one has to be extremely careful when they define “inflation” as good for gold.

If we enter a period of rising interest rates and a stronger US Dollar, gold is going to encounter headwinds as long as inflation pressures are not seen by the markets as excessive.

Also, growth tends to feed stock prices.

Just a bit of perspective….

 

 

 

 

 

 

 

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