Treasury Yields, The Gold Price Thermometer

In recent weeks, analysts and investors in precious metals have been paying close attention and mentioning the evolution of treasury yields, to determine what may happen to the price of gold. Indeed, these yields have become one of the factors that have most influenced the level reached by the precious metal. Why are they so related? What should we look at?

In previous posts we have explained that there are a number of investment assets that tend to compete with gold for the favor of investors. These include stocks (with higher risk than gold) and treasury bonds, the latter with a more similar profile to precious metals.

Both gold and treasury bonds are assets that are usually present in the portfolioos of prudent investors.

What Are The Bonuses?

Bonds are debt instruments issued by a company or public administration to finance itself. The issuer undertakes to return the money to the buyer of that bond, plus previously fixed interest, known as a coupon. That is why it is known as a fixed income instrument.

The returns, therefore, are the profits that the investor will obtain for having acquired that bond, which will be a benefit when the time of maturity arrives, for example, at 10 years.

These yields fluctuate during their term, depending on various variables, such as official interest rates or the level of inflation.

Typically, when we talk about bond yields relative to the price of gold, we are referring to the 10-year US Treasury bond, which is the most widely spread.

In fact, the yields on these bonds have been the main obstacle gold has encountered since the beginning of this year, preventing it from holding on to the record price level it reached in 2020.

Thus, yields on 10-year US bonds rose from 0.90% at the beginning of last January to 1.77% (their highest in 15 months) on March 30.

Another issue is real bond yields, which are obtained by discounting inflation from nominal yields. In this case, although real yields have also increased during this period, more importantly, they have remained in negative territory (because interest rates in the United States have been near zero for some time).

Returns And Opportunity Cost

When treasury yields rise, investor interest in treasury increases as well, while gold looks less attractive.

It is often said, therefore, that the increase in bond yields increases the opportunity cost of owning gold. By opportunity cost we understand the value that we give up when we choose one option and not another. That is, in the case of gold, its opportunity cost is the money that we would have been earning if we had invested in bonds instead of the metal.

That is why gold and bonds have a negative correlation: when one goes up, the other goes down and vice versa.

In the attached graph, this inverse relationship between the yields of the 10-year US Treasury bonds and the price of gold can be perfectly appreciated, between January 2019 and April 2021.

According to the latest Precious Metals Weekly report from the consultancy Metals Focus , the rise in bond yields is the consequence of a combination of factors, among which are optimism regarding the economic recovery, the deployment of vaccines and the announcement of new fiscal stimuli in the United States.

The increase in inflation expectations, which rose in the United States in March to its highest level since 2006, will also contribute to this.

However, since the beginning of April the rebound in bond yields has stopped, which at the end of the month had fallen 0.20% from the maximum registered in March.

This has caused the rebound effect in the price of gold, which has recovered ground and registered its maximum of the last seven weeks, with 1,790 dollars an ounce.

Future Evolution

The uneven economic recovery between countries will dampen optimism among investors, not to mention the possibility that new waves of infections will force further lockdowns.

Furthermore, Metals Focus believes that even if bond yields continue to rise, inflation growth will absorb them, and real yields will remain negative, which is good news for gold.

From The Mine To The Safe: How Is Gold Refined?

Since a mining company extracts gold-rich ore from the earth until a coin is minted or an ingot or jewel is made with this metal, time passes and many industrial processes have evolved for centuries. It is the process known as refining, which converts a raw mineral, with numerous impurities, into a metal with a purity greater than 900 thousandths.

First of all, it must be clarified that what is extracted from the mines is not gold: it is tons of earth with a concentration of just a few grams of metal per ton.

That land is taken to a special plant for processing, which is in charge of separating the gold from the rest of the materials. This plant is usually close to the mining operation, although it is not uncommon for several mines to share the same processing plant, for reasons of cost or organization of the company.

Once this material that has been extracted from the mine has been processed, the result is a series of bars (they are too coarse to call them ingots) of a material called doré, which is actually an alloy of various metals, mainly gold and silver.

The composition of this doré can vary depending on the company that produces it and the mine from which it was extracted. For example, the doré bars received by the Western Australian Mint , the Perth Mint , for refining are typically composed of 70-80% gold and 10-15% silver .

These bars are sent to the refineries, which are the plants where sophisticated physical and chemical processes are carried out to eliminate impurities from the metal until it is left in an almost pure state.

The main European refineries are concentrated in Switzerland and, specifically, in the Italian-speaking canton of Ticino . In fact, Switzerland typically refines approximately 70% of the world’s gold each year .

The London Bullion Market Association (LBMA) Accredited Refinery Good Delivery List brings together the world’s leading refiners. The six most important on this list account for around 90% of the gold refined worldwide annually.

Most of the gold circulating in Europe, in any of its forms, comes from these four large refineries.

Once the refinery receives the doré bars sent by the mining company, they are weighed and melted to ensure that the metal is homogeneous, that is, that there are no points of greater or lesser metal purity inside.

When this amount is determined, a document called an ‘outturn’ is sent to the mining company containing a statement of the weight of the doré bar, the percentage of gold and silver it contains and, based on that data, the amount of gold and pure silver that can be mined.

The mining company, once the document is received, then decides whether to sell the gold and silver to the refinery or carry out a ‘crazy swap’ with it, which consists of an exchange of the precious metals that are in different places, without the need for move them.

Refining process

The doré first goes through a chlorine refining process, known as the ‘Miller process’ . Named after the chemist who devised it, Francis Bowyer Miller , this process is used to refine gold to a high degree of purity.

It consists of blowing a stream of pure chlorine gas over and through a crucible filled with molten gold containing impurities. These impurities, as well as silver and other metals that may be in the doré alloy, react with chlorine to form silver chloride and other compounds, which are deposited on the surface.

The result of this process is gold with a purity of 99.5%, which is later melted in molds to form banked ingots of 400 troy ounces (12.44 kilos) that are used in international banking transactions.

For its part, the silver chloride obtained is subjected to a leaching process to eliminate the rest of the metals and, later, to electrolysis, which allows pure silver to be obtained.

Pure gold

Returning to gold, sometimes the market demands that this metal have an even higher purity. In these cases, the 99.5% pure gold obtained by the Miller process is put through a new process, called the ‘Wohlwillprocess’ , named after the German electrochemical engineer Emil Wohlwill .

It consists of using lower purity gold as an anode and subjecting it to an electrochemical reaction in which the cathode is made up of 24-carat gold sheets or stainless steel.

Once the current is applied, the anode dissolves in the chlorine solution and pure gold ends up coating the cathode.

This is melted down to obtain gold granules of 99.999% purity . These granules are of different sizes, in order to achieve the exact weight needed when melting them into ingots.

The pellets are combined to fill the smaller ingot molds, ranging in weight from one kilo (32.15 ounces) to half an ounce (15.55 grams) . These ingots go through a process similar to coin minting (‘minting’) that gives them their final rectangular shape, with the characteristic marks or designs of each refinery.…

Gold As A Hedge Against Inflation

In addition to the speed at which the global economy is going to recover from the impact of the coronavirus pandemic, the other indicator that keeps analysts and investors around the world on edge is inflation. Its possible growth above 2% per year is a cause for concern and, at the same time, an opportunity for the gold market, an asset that provides excellent protection in times of high inflation. In this post we are going to see what relationship there is between inflation and gold.

The world gold market is currently watching the evolution of the inflation rate in the United States, which may decisively influence the future of the gold price and cause the Federal Reserve interest rates to rise again, after of many months immobilized around zero.

The latest estimates made by the Fed suggest that inflation will close the year at 2.25%, a quarter of a point above previous forecasts. The question is whether it will continue to increase during 2022, and at what rate.

What is inflation?

Inflation is understood as the general and sustained increase in the prices of goods and services in a country over a period of time, generally a year.

This increase causes less goods and services to be purchased with each monetary unit, that is, a loss of the purchasing power of the currency, whose real value as a means of exchange and unit of measurement of the economy decreases.

The level of inflation is measured by the Consumer Price Index (CPI) , which is made up of a ‘basket’ of goods and services that are considered representative of the structure of the economy of the country in question.

The monthly evolution of these prices is measured by a rate, CPI or ‘cost of living’, which generates an annual index that is the inflation rate.

In normal situations, this rate is one digit and less than 3%, which is known as moderate inflation.

The problem is when it starts growing at double or even triple digit levels. In this case, analysts speak of ‘galloping inflation’ , which becomes ‘hyperinflation’ when the index increases by 50% per month (almost 13,000% per year).

The countries that are in this last situation (Venezuela, Zimbabwe, Germany of the Weimar Republic, in the 20s of the last century) suffer a brutal devaluation of the currency, which loses practically all its value.

In fact, some of them had to issue bills worth up to a trillion currency units to offset the drop in currency.

Inflation and gold

What is the relationship between the inflation rate and gold? In a recent report, published on April 21 by the World Gold Council , this body elaborates on the relationship between the precious metal and this economic indicator.

According to the report, “as the global economy and financial markets begin to recover from the Covid-19 pandemic, the main concern for many investors is the new outlook for rising inflation. Especially in the United States, where investors have been accustomed to low inflation for more than three decades .

The reason for this increase is that the rapid recovery of the economy is causing supply tensions in many areas, which influences the price of raw materials.

In addition, the large increase in global debt, the million-dollar economic rescue plans launched by governments such as the United States and the permissive policy of central banks towards inflation suggest that it will grow.

Faced with this situation, the World Gold Council recalls that there are several factors that determine the effectiveness that an element of protection against inflation must have: sensitivity, confidence, cost, liquidity and diversification .

The analysis carried out by this organization between a series of investment assets and their ability to carry out a task of protecting investors’ portfolios in the face of rising inflation reveals that gold is one of the most consistent, always scoring first or second place in the various inflationary periods analyzed.

Gold as protection

The conclusion of this World Gold Council study is that “over the long term, gold acts as a key strategic asset in investors’ portfolios, not only because of its diversification benefits, but also because of its performance. Gold’s relationship to the money supply shows that the metal’s huge appreciation since 1971 makes sense. Its ability to protect against general price increases suggests that its long-term performance is always positive, something that few long-term investment portfolios today can boast .

Therefore, faced with an economic situation in which a rise in inflation above the expected limits is considered as a more than probable scenario, the best form of protection is to entrust part of our assets to physical gold .

The metal, in the form of coins or ingots, constitutes the best protection against rising prices and the consequent loss of purchasing power caused by the devaluation of ‘fiat’ currencies, or based on simple trust in the issuing central bank.

A lesson that many investors have learned throughout history and that should not be lost sight of at this time.…

Gold And Its Value Compared To Other Assets

We are used to hearing about gold as a very valuable element. This value comes in part from its physical and chemical properties, from its applications for industry, jewelry, technology, medicine. But also the fact that it is a very scarce element in the earth’s crust, compared to others. In the field of investment, gold is also highly appreciated by its comparison with other assets.

To determine that gold is a very valuable element, it is necessary to compare it with something, to establish a measure that indicates where it is compared to others.

One of the ways to do it is by its price, which is nothing more than its comparison against a monetary unit, in this case the US dollar. By convention, the official price of gold is established in dollars per ounce, although each country compares it with its own monetary unit, which, in turn, fluctuates with respect to the model currency.

Thus, at the end of the year, gold may have appreciated more in one currency than in another, depending on what this currency has done with respect to the dollar.

Apart from the price, which is still a comparison of the metal with a currency, gold can be compared with other precious metals (silver or platinum), with other raw materials (oil) or with other investment assets (the stocks or treasury bonds).

Gold comparisons or ratios

These comparisons can be made because gold shares a series of qualities with them: its status as a precious metal, as a raw material or as an investment asset. Your assessment, higher or lower, will depend on what you can do with respect to the rest of the elements with which you are compared.

When analyzing the prospects for the evolution of gold, analysts handle these comparisons of the precious metal with other elements or assets. They are called ‘ratios’.

By ratio we understand the quantified relationship between two magnitudes, which reflects their proportion. One of these magnitudes is always gold, and the other varies depending on what you want to compare.

As Andrew Lane points out from the Investing.com blog , “the yellow metal is one of the oldest standards when it comes to measuring the price against different financial instruments” and points to the three most important ratios that can shape the trajectory of gold in the near future: gold/silver ; gold/Dow Jones ; and gold/debt .

There are other ratios that are also used, such as the gold/oil ratio, which we’ve already talked about in this blog , or even the gold/beer ratio , devised by Incrementum , a Liechtenstein-based wealth manager.

However, we are not going to dwell on them in this post, since they are less influential when it comes to assessing the future trajectory of gold.

Gold/silver ratio

We have also dealt with the gold/silver ratio in another post , although it does not hurt to return to it, due to the interest it has recently acquired.

This ratio measures the number of ounces of silver needed to purchase one ounce of gold. As they point out from Investing.com, it is the best known and used of all gold comparisons.

It is estimated that gold is extracted from the earth’s crust in a proportion of 1 to 8 with respect to silver , although it must be taken into account that, unlike the former, only 30-35% of the annual production of the latter is extracted directly; the rest is obtained as a by-product of the extraction of other minerals, such as gold, copper, lead or zinc.

At the time of writing this post, the gold/silver ratio was around 68 ; that is, it takes 68 ounces of silver to buy one ounce of gold. Its historical minimum was in 1980, with only 15, while the maximum was registered last year, in the midst of the Covid-19 pandemic, with 125.

Throughout the 20th century, the gold/silver ratio has averaged 47, so compared to today’s level, silver is still very cheap when you consider that the price of gold is only $180 off its all-time high. Silver, for its part, is trading at 40% less than its maximum price.

Given that silver tends to appreciate at a higher rate than gold in bullish periods like the current one (47% in 2020 compared to 28% for gold), analysts believe that the gold/silver ratio will decrease as silver goes up appreciating relative to gold.

Gold/Dow Jones ratio

One of the investment assets that gold is often compared to is stocks. For this reason, for many years the gold/Dow Jones ratio has been used to relate both elements. This ratio measures the number of ounces of gold needed at a given time to match the Dow Jones Industrial Average , an index that measures the price of the 30 largest corporations on the New York Stock Exchange .

As Andrew Lane explains, “it is an excellent scale to compare two magnitudes that have been used as a scale of the economy and that have almost always maintained an inverse relationship. In good times, when the economy is booming, the Dow Jones is very attractive and there is little incentive to invest in gold. On the contrary, in times like the present, gold is the most convenient asset to own, while the Dow Jones is undervalued .

In 2020, it took just 15 ounces of gold to equal the Dow Jones index, while at the moment the ratio has risen above 18 ounces.

Gold/debt ratio

The third ratio relative to gold that we are going to see is the one that puts it in relation to debt and that, from Investing.com, is the most relevant at the moment.

Currently, the average debt of the countries of the world stands at 300% of their Gross Domestic Product (GDP) . Taking into account that the gold/debt ratio has historically been between 20 and 40% of global debt , this means, according to Investing.com, that the current level of debt could cause an explosion in the price of gold, That would bring it to $6,000 to $12,000 an ounce .

It must be taken into account that, of the three ratios exposed, this is the one with the least mobility. Variation in the price of silver or gold causes the gold/silver ratio to rise or fall rapidly; and what to say about the volatility of the Dow Jones.

However, in the case of debt, the situation cannot change decisively in a short period of time, but rather in the very long term.…

Why Did The Price Of Gold Fall In June?

The year 2021 is contemplating ups and downs in the evolution of the price of gold. The latest correction took place during the month of June, in which the precious metal fell more than 7%, in what was its biggest monthly price drop in the last decade. The monetary policy of the Federal Reserve, the appreciation of the dollar, the competition from other assets… what were the causes of this fall in gold in June?

Indeed, last June the price of gold fell by more than 7%, a downward movement that was the sixth largest since the beginning of 2010. Various factors came together to accelerate a fall in the price of which the metal precious has already recovered.

As Jordan Eliseo , head of research at Australia’s Perth Mint , points out , two of the other top 10 monthly gold price declines (the one in February this year and the one in November 2020) are part of the current cycle of corrections that began mid-August 2020, once gold recorded its all-time high, exceeding $2,050 an ounce.

Although it might seem that gold has not fulfilled its role as a refuge asset during the Covid-19 pandemic, since its price has fallen between June 2020 and 2021, the truth is that gold is still 16% lower. above the level it was in January 2020, when the world began to recognize the threat of the coronavirus.

Also, gold is 50% above its price in September 2018 , which was the time when central banks in developed countries began adopting dovish monetary policies in an attempt to stimulate weak levels of economic growth.

In any case, from the Perth Mint they emphasize that “although the long-term gold revaluation figures continue to be impressive, there is no doubt that the recent weakness has affected the confidence of certain segments of the precious metals market. There was a notable decline in bullish positions in the futures market during the month of June, especially in recent days, while ETFs witnessed some capital flight .

All of this has weighed on investor sentiment towards precious metals, while technical indicators have fallen to levels that typically coincide with bottoms.

Fed intervention

The Perth Mint report agrees with most analysts in citing the Federal Reserve Board meeting in June as a trigger, in which the possibility of a rise in interest rates in 2023 was noted, sooner than expected.

“It cannot be said that the Fed was in a hurry to withdraw the extraordinary stimuli it is injecting into the markets and, indeed, at its June meeting it reaffirmed its commitment to buy $120 billion a month in Treasury bonds and mortgage-backed securities. , in addition to maintaining interest rates between 0 and 0.25%” , warns Eliseo.

However, the markets’ radical interpretation of this change in tone at the Federal Reserve served to boost the dollar (which has risen 3% since the end of May) and to cause real bond yields to rise, which which has contributed to the correction in the price of gold.

The Perth Mint report points to five factors that have contributed to this historic 15% correction in the price of gold since it registered its all-time high in August 2020:

Stabilization of real yields on treasury bonds

Over the long term, the price of gold is closely correlated with real bond yields. Since gold peaked in August 2020, real yields on 10-, 20-, and 30-year US Treasury bonds have grown, or at least are less negative than nine months ago.

Rise of the bags

Since the Covid-19 pandemic caused the stock market crash in March 2020, capital markets around the world have registered an unprecedented rally: the Australian ASX 200 is up more than 50%, while the S&P 500 of the New York Stock Exchange has nearly doubled.

In the first six months of 2021, this latest US stock market index has risen by close to 40%, in what has been one of the biggest ‘rallies’ in the last 50 years.

Given such a rise in markets, it is not surprising that investor appetite for gold has waned in recent months, putting downward pressure on the price of the metal.

Growing optimism about the economy

Investors’ optimism regarding the rate of recovery of the global economy has also grown in recent months. The vaccination of the population in most developed countries and the fiscal stimulus measures that have supported households and businesses have contributed to this optimism.

Global growth forecasts are constantly being revised upwards, while US consumer confidence soars, reaching levels it was 18 months before the pandemic.

Bitcoin and cryptocurrencies

The year has also been very positive for bitcoin and other cryptocurrencies, despite the recent 50% correction in the price of the main virtual currency.

On the day the gold price peaked, in early August 2020, bitcoin was trading at less than $12,000. Subsequently, it multiplied by five, reaching $65,000 in mid-April of this year.

Even discounting the 50% correction, the price of the cryptocurrency is more than triple its price when gold peaked. This has attracted the attention of many investors, especially younger ones, which has ended up weighing on gold.

Excess of optimism in the precious metals markets

The last factor that has influenced the correction of the gold price is what in the Anglo-Saxon countries call ‘froth’: an excess of optimism among investors, which usually precedes the bursting of a bubble.

This would mean that gold became too popular an asset and made headlines when it broke above $2,000 an ounce. The optimistic sentiment among investors and analysts was the usual sentiment that occurs just before an asset undergoes a correction.

According to Eliseo, the good news is that this excess of optimism has dissipated and, although this does not mean that the market has bottomed out, the situation is more balanced, which is a positive sign.