gold investment, silver investment

Precious metals investment terms A to Z

Bond Yields

A bond yield is a return on investment, expressed as a percentage, for a bond. Investors often analyze the Treasury yields, i.e. the returns on the U.S. government’s debt obligations. The price of bonds is negatively related to the yields they offer. Since there is a negative relationship between gold and the interest rates, there should be negative correlation between the price of gold and bond yields and positive correlation between gold price and bond prices. In other words, there may be a positive relationship between gold and bonds due to the opportunity costs and capital flow from bonds to gold, when prices of bonds become too high (yields become too low). There may also be capital flows in the opposite direction (from gold to bonds) when bond yields increase (bond prices decrease) and provide a better alternative than gold.

Treasury Yields

This is especially true in the case of U.S. Treasuries (i.e. government debt instruments issued by the United States Department of the Treasury to finance the national debt of the United States). They are considered a safe haven – but one which pays a yield. In other words, a “fear trade” may increase demand for both gold and bonds. The latter are generally anti-cyclical, while gold is noncyclical, but both asset classes may sometimes move in tandem responding to changes in the stock market, as a non-confidence vote in the U.S. economy.

However, the data does not confirm the positive relationship between gold and the bond market. The chart below presents the price of gold and the 10-year Treasury constant maturity rate (the 10-year Treasury is considered a benchmark in the bond market, or at least in the long-term part of it, as it is one of the most widely held fixed income securities in the world). The rates are in reverse order to show the trend in bond prices (which are inversely related to the yields).

Chart 1: 10-year Treasury constant maturity rate (in percent, green line, left axis, values in reverse order) and the price of gold (yellow line, right axis, London P.M. Fix).

10-year Treasury constant maturity rate (in percent, green line, left axis, values in reverse order) and the price of gold (yellow line, right axis, London P.M. Fix).

As one can see, the price of gold was rising in the 70s, despite the fact that bond prices were falling and rates were surging. Since the 1980s, there has been a long upward trend in bond prices, seemingly not related to changes in the gold market, as the shiny metal was in a bear market during the 1980s, the 1990s and in the last few years, and in a bull market during the 2000s. This visual analysis is confirmed by more sophisticated research conducted by Baur and Lucey in their academic paper “Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold”, where they found that gold is neither a hedge nor a safe haven for bonds.

This is because what really matters for gold are real interest rates, not nominal yields (high and accelerating inflation rates affect gold and bonds differently). The chart below shows a significant positive correlation between the price of 10-year inflation-indexed Treasuries and the price of gold, or a negative relationship with real interest rates (the 10-year inflation indexed Treasury rate is a proxy for U.S. long-term real interest rates). The rates in the chart are in reverse order to show the trend in bond prices (which are inversely related to the yields).

Chart 2: 10-year inflation-indexed Treasury rate (in percent, green line, left axis, values in reverse order) and the price of gold (yellow line, right axis, London P.M. Fix).

10-year inflation-indexed Treasury rate (in percent, green line, left axis, values in reverse order) and the price of gold (yellow line, right axis, London P.M. Fix).

From the trading perspective it’s possible to use the short- and medium-term movements in the yields as trading signals. Please take a moment to examine the chart below (courtesy of http://stockcharts.com):

UST20Y:UST1Y - Gold and ratio of US Treasury Yields

When long-term yields quickly outperform short-term yields (which we can measure using the Rate of Change indicator) we are likely to see a top in gold – usually a major one. We saw this important (yet little known) signal on multiple occasions and the gold price swings that followed were often huge.

To sum up, as in the case of stocks and gold, there is no simple causal link between bond and gold prices. The sometimes observed positive correlation between bond prices and the shiny metal results from the facts that bonds and gold might be perceived as substitutes due to opportunity costs. Another reason are the changes in confidence in the fiat dollar-denominated system, which prompts investors to divert funds from the stock market to gold and bonds. The fact that the yellow metal price is not driven by stocks or bonds confirms the thesis that gold is a good portfolio diversifier, and that it should be considered not as an asset class, but rather as a special non-fiat currency – a non-confidence vote in the U.S. economy.

We encourage you to learn more about gold – not only how it is affected by bond (Treasury) yields, but also how to successfully use the shiny metal as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It's free and if you don't like it, you can easily unsubscribe.

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