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What drives the price of gold and what are the key correlations?

Gold_Silver

The gold price directionally continues to follow real interest rates, inversely:

Chart Source: St. Louis Fed

Notably, gold is following real rates as measured by 10-year Treasury yields minus 10-year inflation breakevens (the difference between normal Treasury yields and TIPS yields), not rates minus current year-over-year CPI growth. Treasury rates minus current year-over-year price inflation are actually in profoundly negative territory, whereas Treasury rates minus inflation breakevens are merely rangebound.

Since gold is a financialized asset, it follows what financial markets are saying, and that’s inflation expectations measured by the TIPS market breakevens rather than current inflation.

Gold has been in a correction/consolidation ever since August 2020, when real Treasury yields measured by breakevens reached a low point of -1.08%.

What would make inflation breakevens go up, and thus for deeper negative real yields to occur? There are two main possibilities. One possibility would be a sustained rise in energy prices and/or a sustained rise in wages, while Treasury rates remain low due to policy intervention. That would likely boost inflation expectations and thus lead to deeper negative real yields. The other possibility would be that Treasury rates get pushed lower due to concerns of a weakening economy. At the same time, inflation expectations remain flat or otherwise don’t go down as much, and thus real yields go into deeper negative territory.

As of right now, the market is still grappling with how to interpret inflation, and part of the world remains in lowdown (particularly Southeast Asia at the moment), with unclear virus variants and possible lockdowns that could arise over the next 6+ months.

I remain long-term bullish on precious metals as part of a diversified portfolio.

When it comes to short-term trading, I still hold both buy and sell trades. Both secured with a stop-loss level in positive territory. 

Technically, it starts to get ugly, and that’s the result when both instruments are strong “gold vs USD”, and this ugliness is expressed in short-term consolidation in the shape of the “Head and Shoulders” bearish chart pattern. 

On the other hand, the Commitment of Traders reports still shows signs of bullishness and the long-term technical wave cycle is still intact.

However, if the price breaks below the 1790 level of support, my short-term buy trade will be closed at break-even, and the sell trade will continue profiting. The downside targets will be 1770, 1760, 1750 next. 

Regarding the short-term bullish scenario, if the price respects the current level of support 1790 and shows bullish price action, I will be more than happy to buy the dips with a greater risk: reward ratio and close the profits realised sell trade. 

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Continue reading the Energy sector Report here

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