SLV - Gold: Bond Yields May Have Peaked But That's No Buy Signal

2023-08-09 22:24:24 ET

Summary

• Both nominal and real bond yields appear to be peaking across the curve, which is positive for gold, all else equal.
• However, the metal is already elevated relative to its fair value based on real bond yields and industrial metals prices, while the technical picture suggests further downside to come.
• The US' dire fiscal situation suggests gold will perform well over the long term, but a sharp dip maybe required before the longer-term bull market resumes.

Recent price action in bond markets suggests yields are topping out across the entire curve. Last week's spike in yields may well have marked the peak as real yields are now far higher than are sustainable in a slow growing and debt ladened economy. This is good news for gold as the opportunity cost of holding the metal is highly likely to decline. However, as I argued in early June, gold is already extremely elevated relative to current real bond yields and industrial metals prices, suggesting now is not the time to buy.

Gold is resting on uptrend support from the March lows and for now has managed to maintain its trend of higher lows. A break below here though, and a close below $1,900, would put the focus on the downside, and open up a potential move to the lower end of the three-year trend channel. The February lows at around $1,800 would become a clear downside target, with little support beyond here until $1,600.

The price action of other precious metals such as silver and platinum also highlight the downside pressure on the sector, while net non-commercial positioning on gold remains heavily long which is more likely to occur at market tops than bottoms.

Fair Value Significantly Lower

Even such a large drop to $1,600 would still leave the metal overvalued based on its historical drivers. The following chart shows the fair value of gold based on its historical relationship with industrial metals prices, 10-year bond yields, and inflation expectations going back to the 2008 lows.

For the vast majority of this period gold has moved up during periods of falling real bond yields and rising industrial metals prices and vice versa. Over the past year, however, the surge in real bond yields and fall in industrial metals has driven gold's fair value down sharply but gold itself has remained elevated. It would take roughly a 50% rise in industrial metals prices and a 200bps move lower in 10-year real bond yields to justify the current gold price.

Recession Not Necessarily Bullish For Gold

While I expect real bond yields to move lower over the coming months reflecting the deteriorating real economic growth outlook, there is a risk that another financial crisis drives up demand for cash and causes inflation expectations to fall faster than bond yields. This was the case in the Global Financial Crisis when interest rate cuts were not fast enough to offset the surge in demand for cash, causing real yields to surge and gold prices to fall 34% peak to trough.

Long-Term Outlook Is Positive But TIPS Are Far Superior

From a long term perspective I expect gold to perform well as the US's dire fiscal position will mean that real bond yields will ultimately have to be brought back below zero to prevent a fiscal crisis. As I argued recently here , at current interest rates, US Treasury interest payments are on track to reach 8.5% of GDP by 2028. To be bearish on gold over the long term is to believe that the US will proactively deal with the deficit by cutting spending, which has never been done before.

However, in the meantime, US inflation-linked bonds are a far better option for investors looking to benefit from falling real bond yields. With 10-year inflation-linked bonds yielding around 1.7% this means that gold would have to rise by 1.7% annually in real terms just to hold its own relative to bonds. As was the case in previous gold bull markets, a sharp correction is often needed to shake out weakly held long positions and set the stage for the next leg higher.

For further details see: