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The Unprecedented Factor Driving Gold Higher

25 Jan 2017 5:41 am

By Ben Eisen

To see why gold has been on a tear, look to the bond market.

Though the precious metal is sometimes seen as the safe-haven investment choice of those who distrust the financial system, a lot of its price moves can actually be traced to something less fear-inspiring: inflation-adjusted interest rates.

That's a factor explaining at least part of gold's 5.7% climb this year through Monday to its highest since mid-November, analysts say.

"We think that the biggest driver of gold prices is absolutely real yields," said Nicholas Johnson, a commodities portfolio manager at Pacific Investment Management Co., who published research on the topic in 2014.

Analysts say that typically, the higher real yields are, the less investors are willing to pay for an asset that doesn't offer inherent income, like gold. The lower the yield offered by inflation-adjusted bonds, the less the trade-off in owning gold, and the more investors are willing to pay for it.

Some say that's not the only factor driving gold prices. After all, there's a lot of fear of unknowns in the world right now, one factor prompting investors to buy up gold. Plus, the U.S. dollar has been weakening recently, which tends to push gold higher.

But the negative correlation between gold and real rates -- where gold falls as inflation-adjusted yields rise, and vice versa -- is stronger than ever. The three-month correlation between daily changes in U.S. real yields and daily returns on gold is "unprecedented," having fallen to the most negative in records going back to the middle of 1997, according to Bank of America Merrill Lynch.

And it's not just gold prices. Gold miner stocks, which are typically leveraged to the price of gold, currently have their most negative correlation with real yields in records going back to 2007, according to Ned Davis Research Group. They came up with that calculation by looking at the 52-week correlation between weekly changes in the Market Vectors Gold Miners exchange-traded fund, and the 10-year real Treasury yield.

All of this helps explain how gold managed to rebound over the past month, even as stocks and other risky assets that shot higher after the election have largely traded in narrow ranges .

Immediately after the presidential election, inflation-adjusted bond yields jumped, and prices fell, as investors began expect more inflation under Donald Trump's administration. Now, inflation expectations remain elevated, but real yields, as measured by the rates on long-term Treasury inflation-protected securities, have been paring their rise over the past month. Yields have generally come off their highs as investors begin to second-guess parts of the so-called Trump trade. As such, the performance of TIPS has begun to bounce back.

And as real yields fell, gold was poised to rebound.

(END) Dow Jones Newswires

January 25, 2017 00:41 ET (05:41 GMT)

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