Gold Versus Real Yields: Are Inflation Bets Fully Priced Into XAU/USD?

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Gold Fundamental Forecast: Neutral

• Rising real yields have dirtied the yellow metal’s luster
• Gold fails to follow increasingly bullish bets on inflation
• Inflation-adjusted gold prices near historical highs, where next?

Gold edged higher on Friday as the US Dollar weakened, ending the week on a positive note following seven consecutive down days for the precious metal. Still, the yellow metal recorded its worst weekly performance since early January, falling close to 2.5%. One reason for the recent weakness is rising treasury yields, more specifically, rising real yields.

Gold (XAU/USD) 6-Hour Price Chart

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Real yields – nominal bond yields minus the breakeven inflation outlook – have risen as investors price in a $1.9 trillion Covid relief package. While the proposed stimulus has bolstered inflation bets, it appears to have propelled sentiment surrounding an economic rebound relatively further. Hence the pace at which we have seen real yields rise as investors ditch government bonds.

Nevertheless, inflation-adjusted Treasury yields remain near historic lows despite the recent ascent. Conventional market understanding suggests gold prices may continue to drop if this trend continues. Investors are shifting capital into riskier assets as the reflation theme strengthens. As government debt is ditched for riskier assets, bond yields increase, which in turn attracts investors away from the non-interest bearing gold.

So, what about gold as an inflation hedge? Inflation bets are rising, but inflation itself remains elusive. Consumer prices may very well rise – especially considering the amount of stimulus being pumped into the financial system. However, inflation-adjusted gold prices (gold/CPI) are already near historical highs as shown in the chart below.

The impact from rising inflation bets may have already done as much as it can to support gold prices. Tangible and substantial increases to inflation may be needed before gold gains its luster back. The upside, if any, is likely limited for now. That said, next week’s US PCE figures may provide some direction for the yellow metal, although the month over month change is expected to cross the wires at 0.1%, according to the DailyFX Economic Calendar.

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--- Written by Thomas Westwater, Analyst for DailyFX.com

To contact Thomas, use the comments section below or @FxWestwater on Twitter