Real yields and gold - Capital Economics
Asset Allocation

Real yields and gold

Asset Allocation Update
Written by John Higgins

The recent drop in the price of gold below $1,700/oz. has illustrated its greater sensitivity to US long- than short-dated real yields. Although the price has nudged back up above this level at the time of writing, we expect it to fall back to an even lower level as the US real yield curve steepens more.

In view of wider interest, we are also sending this publication to clients subscribed to our Metals Service.

  • The recent drop in the price of gold below $1,700/oz. has illustrated its greater sensitivity to US long- than short-dated real yields. Although the price has nudged back up above this level at the time of writing, we expect it to fall back to an even lower level as the US real yield curve steepens more.
  • Gold is a real asset whose value has risen by more than the general price level in the US over the past century and a half. (See Chart 1.) Admittedly, the price of gold was fixed for much of the first hundred years of this period, preventing it at times, for example, from adjusting to higher inflation in the US economy. But it compensated for this by soaring after the US dollar’s convertibility to gold ended in 1971.
  • Aside from the general price level, the price of gold is determined by myriad factors affecting demand for, and supply of, the metal. One of these is Treasury yields, because gold does not pay any interest. When yields rise, the price of gold ought to decline since this increases the opportunity cost of holding the metal.
  • It has been argued that the role of Treasury yields in influencing the price of gold is exaggerated because of what occurred in the 1970s. In that decade, Treasury yields rose sharply, yet the price of gold soared. (See the area to the left-hand side of the dotted line in Chart 2.) What’s more, the opposite was true for much of the early 1980s. Yet this is a flawed argument, in our view, precisely because gold is a real asset.
  • It makes sense to us to compare the price of gold with the real yields of Treasuries. Unlike nominal yields, these were falling in the 1970s as the Fed fell “behind the curve”. (See the area to the left-hand side of the dotted line in Chart 3.) This makes the rise in the price of gold then much less puzzling. (See Chart 4.)
  • In the past, short- and long-dated real Treasury yields have often moved in the same direction, with the result that both variables have had a close inverse relationship with the price of gold. This co-movement of short-and long-dated real Treasury yields is hardly surprising, since a portion of the real yield of a long-dated government bond captures expectations for the short-term real rate during that bond’s remaining life.
  • Since the good news on vaccines against COVID-19 began to emerge in November, however, short- and long-dated real Treasury yields have moved in opposite directions. (See Chart 5.) Short ones have fallen amid repeated signals from the FOMC that monetary policy is likely to remain very loose for a long time, despite a big pick-up in inflation this year amid a strong economic recovery and huge fiscal stimulus. Long ones, though, have risen as investors have increasingly assumed that the flipside will be tighter policy down the road than would otherwise have been needed to bring inflation back down towards the FOMC’s target.
  • The pivoting of the real yield curve has been accompanied by a slump in gold. Accordingly, the inverse relationship between the US 10-year zero coupon (ZC) real yield (implied by conventional Treasuries and US inflation swaps) and its price has remained strong, whereas that between the equivalent implied US 2-year ZC real yield and its price has completely broken down. (See Chart 6.)
  • We think this is logical. Admittedly, gold is not like a regular US Treasury Inflation-Protected Security (TIPS) with periodic cash flows and a principal to be repaid when it matures on a given date. Accordingly, the concept of duration is not something that can be readily applied to the metal. Nonetheless, gold is arguably like a hypothetical real zero-coupon perpetual bond, whose duration is potentially infinitely long. With that in mind, it probably should track more closely the real yields of long- than short-dated Treasuries.
  • Our expectation is that the real Treasury curve will continue to steepen. Indeed, we suspect most of the ~50bp increase we project in the nominal yield of 10-year conventional Treasuries between now and the end of this year (see here) will result from a higher real yield. We expect this to heap more pressure on the price of gold, which we doubt will get any offsetting boost from a flight-to-safety given our view that the US stock market will stay strong this year. Our end-2021 forecast for the price of the metal is $1,600/oz.

Chart 1: US Inflation Index & Gold Price
(1871 – Latest) (Rebased: Start = 100, Log Scale)

Chart 2: 10-Year Treasury Nominal Yield & Gold Price
(1971 – Latest)

Chart 3: 10-Year Treasury Nominal & Real Yields
(1971 – Latest) (%)

Chart 4: 10-Year Treasury Real Yields & Real Gold Price
(1971 – Latest)

Chart 5: Changes Since 6th Nov. In ZC US Inflation Swap Rates, Nominal & Implied Real US Treasury Yields (bp)

Chart 6: ZC US Treasury Implied Real Yields & Gold Price (2019 – Latest)

Sources: Refinitiv, Shiller, MeasuringWorth, Capital Economics


John Higgins, Chief Markets Economist, john.higgins@capitaleconomics.com