Is gold poised for a turnaround? Alongside a general strengthening in the U.S. dollar, gold prices fell nearly 10% over the past three months and remain at the lower end of their 18-month range. But we think the outlook for gold could be improving – particularly if President Trump’s recent remarks lamenting the strong dollar help reignite interest in owning gold.
The president recently stated that he was “not happy” about the Federal Reserve’s rate increases, and later alleged in a series of tweets that China and the EU were manipulating their currencies and holding down interest rates. The dollar dropped to a two-week low following the president’s statements. And while it’s tough to gauge their ultimate impact on the dollar, the president’s messages could also have knock-on effects on gold and other asset classes, as well as inflation – especially on top of recent trade issues.
Gold fell despite stagnant U.S. real yields
We’ve found the magnitude of the recent gold sell-off on the back of dollar strength surprising, particularly given that real yields on 10-year Treasuries haven’t moved. As we’ve written previously, gold, by its nature, essentially has a real yield of zero – so just as currency movements are driven by real yield differentials, so should be the price of gold. (We refer to real rather than nominal yield because gold prices have historically tended to rise with inflation.)
We’ve observed that over the past decade, gold has traded like an asset with nearly 30 years’ duration (meaning that a 100-basis-point move lower in Treasury real yields has translated to a roughly 30% increase in the price of gold). As yields on U.S. government bonds rise, one would expect investors to marginally prefer those assets, moving out of gold and into Treasuries and Treasury Inflation-Protected Securities (TIPS). Gold prices should drop in the process – and vice versa, when government bond yields fall.
Investor takeaways: Gold valuations look compelling
Falling gold prices in the absence of rising real yields indicate that gold has cheapened relative to other U.S.-denominated flight-to-quality assets, like TIPS and Treasuries. Correspondingly, our views on gold have shifted toward constructive. In our view, the recent price moves have been driven by investors placing too much emphasis on the value of the dollar and too little on real yields. Ultimately, we think the sell-off will prove transient and that the relationship of real yields to gold observed over the past decade will prevail.
For more of PIMCO’s views on factors influencing gold and other real assets, see our latest inflation outlook, “Inflation Awakening.”
Nicholas Johnson is a PIMCO portfolio manager focusing on commodities and is a regular contributor to the PIMCO Blog.