Gold Rarely Declines with Real Yield. This Time Due to USD Strength

Gold price got dumped, falling to the lowest level in over 2 months. Losing over -7% against USD in June, the selloff this time has been driven by strong US dollar, rather than higher yields. The greenback is darling of the market recently, thanks to strong economic data, a more hawkish Fed and diminished risk appetite amidst the rapid spread of delta variant. An interesting observation is that gold’s selloff is accompanied with lower real yield. We believe this phenomenon is temporary.

Gold’s Selloff Mainly Due to USD Strength

Appreciating against major currencies this month, the greenback made much of the gain after the hawkish FOMC meeting. The members pushed forward the timing of the first rate hike. GDP growth and inflation projections were also upgraded. Over the past few days, the greenback has got another boost on strong data. The Conference Board consumer confidence index jumped +7.3 points to 127.3 in June. This marks the highest level March 2020, signaling that confidence has returned to pre-pandemic level. GDP growth accelerated to an annualized +6.1% q/q in 1Q21, from +4.3% in the prior quarter. The strength will likely carry on. The PCE index, the Fed’s preferred inflation gauge, accelerated to +3.9% y/y in May, from +3.6% a month ago. The core reading also improved to +3.4% from April’s +3.1%.

With a satisfactory vaccination rate, the number of new coronavirus cases has been declining in the US. Before delta virus becomes widespread in the US, the greenback could be more attractive than other major currencies as countries such as the UK, the Eurozone and Australia have already seen resurgence of the pandemic due to the variant. Against this backdrop, the US dollar appears to have also overtaken gold’s role as a safe-haven asset.

A bullish US dollar has pressured gold. This relationship has not been so strong as in this year and in June. The correlation is -0.89 and -0.93 year-to-date and this month, respectively. The 3-year averaged correlation is +0.23.Gold Price and Real Yield Move in Same Direction

As we demonstrated in previous reports, the negative correlation between gold and real rate is prominent in history. Such relationship has been derailed of late. In the aftermath of the FOMC meeting, the 2-year UST yield jumped and has since then been hovering around the highest in 10 months. The 10-year yield, however, increased only modestly. Interestingly, the real yield (TIPS yield) has slipped, albeit modestly, while the yellow metal plummeted. Usually such derailment is temporary.

We believe the sharp selloff in gold represents market expectations of strong economic growth and higher yields. However, the lack of interest in gold as an inflation hedge might suggest that the market buys into central bankers’ viewpoints that elevated inflation is only transitory. We are skeptical about the sustainability of gold selling under the above assumptions. If inflation is to remain subdued in the medium to long term, corporate is doomed to suffer with higher interest rates. This would present a scenario where safe-haven assets like gold are sought after.


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