Gold bounced strongly from the lows as it moves in an inverse correlation with the US 10-year real rates. What will 2021 bring for the yellow metal?
The price of gold rebounded strongly from below the $1,700 level and continues its bullish run. It recently traded above $1,850, in line with a declining dollar and a falling 10-year real rates yield.
The Fed’s dovishness is just one of the reasons for the bullish trend in the gold market. Higher and rising inflation is another.
In the past year, the Fed made no secret that it will remain accommodative beyond the point where the economy will recover. The recovery is here, much stronger than expected, and the Fed does what it promised to do. Hence, the lower US dollar helps to boost the price of gold.
Rising inflation is another reason why the yellow metal’s price makes higher highs and higher lows. Gold has been traditionally viewed as a hedge against inflation.
Real Rates Decline Boosts Gold Price
One of the tightest correlations in financial markets is the one between the price of gold and the US 10-year real rates. As the chart above shows, the inverse relationship between the two is very strong, suggesting that investors are influenced by the level of the real rates and find refuge in gold when real rates decline.
But the chart above is tricky. It shows the tight relationship between the two markets, only it does so in a period with little or no inflation. In fact, inflation was so low in the last decade that it often threatened to turn negative. As such, the correlation may break, should inflation reach unsustainable levels.
Last Wednesday, the market participants were surprised to see inflation for the month of April surging more than four times the forecast. It showed what money printing produces and the estimates are that over the summer, it will continue to rise.
Inflation alone is enough to break the inverse correlation between the price of gold and the real rates. Should inflation reach 8% annualised, it should boost the price of gold even more.
Gold peaked above $2,000 during last year’s US dollar decline, but then corrected in a steady bearish trend. However, rising inflation alone is enough for bulls to predict that the price of gold will make a new all-time high this year.
Will the real rates and gold price correlation break, or will we see more of the same in the months ahead? The answer comes from inflation data.