With inflation being one of the critical risks this year, many analysts are scratching their heads as to why the precious metal is underperforming, especially in light of the crypto’s “safe haven” popularity.
“When we can look at the moves in U.S. inflation expectations, we see 10-year breakevens at 2.22% – the highest since 2014 – and almost consistent with the Fed meeting its inflation mandate over the coming ten years,” said Pepperstone head of research Chris Weston. “Traders have best expressed higher inflation expectations through short duration exposures in bond markets, with the 5s v 30s Treasury yield curve moving into 152bp (highest since 2015), while the short-end 2s vs. 5s has moved from -14bp to currently stand at 38bp (highest since March 2018).
So, why is gold struggling while markets like crude, copper, cyclical stocks and even cryptos are viewed as the “go-to hedge outside of the bond market?” asked Weston.
After starting the year on a muted note, gold has been facing consistent downward pressure from rising yields, higher U.S. dollar, and risk-on sentiment in the marketplace.
“Gold is working lower in the standard deviation channel and struggling to find any buying conviction at all. I guess this makes sense at this juncture, as the market senses inflation. Still, it’s hardly at levels that scream the Fed have lost control – perhaps we need to see U.S. 10-yr breakevens above 3% for that, and that will take months to play out, if at all,” Weston noted.
The inflation scenario, once played out, would see gold come to life this year, Weston pointed out.
“That being we get an overheating U.S. economy driven by a massive closing of the output gap, as the U.S. Treasury unleash $2.8t is fiscal spending this year, while the Fed dismiss inflation as ‘transitory,’ subsequently jawboning the market to suppress the moves in the back end of the Treasury curve. That is the nirvana situation for gold, and crypto, as this is where real yields dive, and rubber stamps gold as a store of value,” he noted.
And while this scenario is a possibility, there is a lot of skepticism surrounding it, added Weston.
“The Fed [is likely to] discuss tapering its bond-buying program later this year and unless we see evidence of a re-run of 2013 (taper tantrum), which the Fed sees as its biggest risk, then I feel they will leave long-end rates untouched, he said. “So, conversely, an overheating economy, with the Fed pulling back on QE and letting the back end rip may actually really damage the gold market, but that depends on the USD and real yields.”
This confusion over what’s in store for gold is also playing out in the futures and the ETF space. Since September, there has been no significant movement in the weekly CFTC report while the ETF space is losing holdings.
“In the ETF space, we’ve seen a near 40% outflow of the GLD ETF through this period. Investors clearly seeing the opportunity cost of being in a yield-less asset when other markets are responding far more cleanly to the economic improvement,” Weston explained.
For now, gold’s range remains between $1,961 and $1,762. “I am happy to trade within in this – however, when it breaks, either side, then that should be respected,” he warned.
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