Gold Prices vs. U.S. Treasury Bond Yields: Only One Can Win

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Gold prices have been in decline despite the weakened dollar. What will it take for the yellow metal to shine again?

Gold has been a source of frustration for investors who bought it as a hedge against pandemic-related economic and political uncertainty. Its price has continually eroded in the last several months, prompting growing concern that perhaps the metal has lost its value as a safety hedge.

I’ll make the case here that gold’s value as a protection against both uncertainty and inflation should remain intact. I’ll also explain what is holding gold prices back and what likely needs to happen before the yellow metal can finally resumes its long-term rise.

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Investors who bought gold during last year’s “pandemic panic” bottom certainly have cause to celebrate. From its intraday low of around $1,450 in March 2020, the yellow metal’s price rose to nearly $2,100 by August in an eye-popping 45% rally. And while gold sagged in the months that followed, it still finished the year higher with a respectable 30% gain.

Gold prices have been in decline since last August.Since the August peak, however, gold has declined 15% and has been in a slump for almost seven months—its longest period of underperformance since 2018 (which saw gold drop 13% in five months).

Needless to say, for gold to spend as much time as it has in the doldrums is very unusual, especially given its tendency to strengthen during periods of economic uncertainty. This has caused many investors to ask: “What is keeping gold from rallying?” and “What will it take for it to finally turn around?”

Why Gold Prices are Falling

The first question is the result of the puzzlement over gold’s currency factor. Since gold is priced in dollars, a decline in the dollar normally results in a corresponding advance in gold prices. But instead of rallying in the face of recent dollar weakness, gold fell 8% from September through February, despite a 4% decline in U.S. dollar index (USD).

It’s not often that gold and the dollar move in the same direction. But when it happens it’s normally the result of a significant countervailing force. In this case, the force in question is the current trajectory of U.S. Treasury bond yields.

Gold, in fact, competes with Treasury bonds; and since gold doesn’t offer a yield, yield-seeking investors tend to favor bonds over gold whenever bond rates are rising. Indeed, the rising 10-year yield has convinced many investors to allocate more of their money to Treasuries at gold’s expense as they remain focused on chasing higher yields. The following chart illustrates the relative strength of TNX versus gold.

Treasury bond yields vs. gold prices.
It has been the assumption of some experts that TNX would hit at least 1.2%-to-1.4% before its uptrend was challenged, and so far, this assumption has held true. The basis for this prediction is the copper-gold ratio, which is the quotient of the price-per-pound of copper divided by the price-per-troy-ounce of gold. Besides being an indicator of the global economy’s health, the copper-gold ratio is also an excellent predictor for the future direction of Treasury rates.

For instance, the copper-gold ratio predicted a 10-year Treasury yield between 1.2% and 1.4% several months ago. (The comparison is made by comparing the current value of this ratio to where the Treasury yield stood a year ago.) The last time the 10-year yield hit 1.4% was last winter, so it only makes sense that we should see TNX reach 1.4%—and possibly a bit higher— before the next “correction” in the 10-year yield.

The copper-gold ratio divides the price of copper by gold prices.

How You’ll Know Gold is on the Rebound

All told, a significant T-bond yield decline is probably what it will take to kickstart the next extended rally for gold. Falling yields will cause investors to reevaluate their choice in safe-haven assets, and lower yields will naturally make owning Treasuries less attractive than owning gold. Moreover, assuming the dollar remains weak, it should serve as an added enticement for participants to own the yellow metal as a hedge against future inflation.

Bottom line: Gold’s next extended upside move isn’t likely to commence until the rising trend in the 10-year yield has exhausted itself. Rising yields will likely continue to exert some downward pressure on gold prices, even as a weak dollar keeps metal prices somewhat buoyant and not far below last year’s highs. For short-term trading purposes, a sharp decline under the 50-day line in the TNX (below) will serve as a preliminary signal that gold is primed for a turnaround.

In the meantime, with industrial metals (like copper, steel and aluminum) and rare earth metals still in a bull market, it’s my opinion that investors are justified in maintaining higher portfolio weightings in these base metals (via stocks and ETFs) versus precious metals. Just be sure to use a conservative money management discipline (or stop-loss strategy) whenever you’re trading the metals markets.

In our Cabot Top Ten Trader advisory, chief analyst Mike Cintolo has provided some highly profitable trading ideas for base metal stocks recently, including Vale S.A. (VALE, up 3%), Cleveland-Cliffs (CLF, up 10%) and Freeport-McMoRan (FCX, up 120%).

Each week, Mike also covers a wide variety of stocks in several major sectors and industries. I highly recommend checking out Top Ten Trader. It’s a great resource for keeping your portfolio in the black until the next gold bull run comes along. And when that time finally arrives, you can rest assured the Top Ten Trader will be on top of some of the best-performing stocks in the precious metals arena.

To learn more, click here.

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