WTF? Bonds Sink, Gold Price Jumps
- Financially because, when interest rates go up, people tend to feel less urgent need of a cold, hard store of value no one can create or destroy, proven across 5,000 years of human history.
- Mechanically because higher interest rates raise the opportunity cost of owning gold rather than holding cash in the bank.
- And immediately, because higher interests also raise the cost of betting that gold will go higher. Whether you bet through Comex futures or forwards in the wholesale physical market, any such contract effectively sees you betting with borrowed money. Higher rates make that bet more expensive. So when longer-term interest rates rise, hedge funds and other players who were betting that gold prices would go up close out their contracts quick-smart.
- The relationship was overdue a snapback. Gold's negative correlation with real 10-year yields set all-time highs in late 2017, reaching a 12-month record of -0.70 against the -0.31 average since 2003. This early 2018 "surprise" is no such thing.
- Alternatively, gold's underlying correlation with real yields did not (and cannot) break down in New Year 2018. Gold's surprising response simply means it is now over-priced at $1350 per once today. Sell, and either look to get back in lower down or quit gold entirely as the US Federal Reserve finally gets ahead of the curve and hikes its key interest rate faster than the cost of living increases.
- Or thirdly, it might be that bond yields are wrong, and gold is calling it right. Inflation will continue to rise, but the US Federal Reserve will fail to raise its key interest rate any faster as a result, and that will eventually feed back into lower bond yields. Because, just like every Fed chair before him (except early 1980s' chief Paul Volcker), Jerome Powell doesn't want to crush the debt-heavy US economy, let alone the US stock market.