Gold at a major point of resolve: vulnerable to rising US bond yields
By Ryk de Klerk
THE V-SHAPED recovery in the US is surprising on the upside, but the recovery, together with massive monetary and fiscal stimulus, is causing concern that inflation is likely to overshoot on the upside.
The housing market is particularly worrying. The fall in mortgage rates and the massive turnaround in employment due to the US moving out of the Covid-19 crisis have led to a feeding frenzy in the US housing market.
Over the weekend, the New York Times reported that homes are selling in record time and the median sale price of existing homes is up by more than 17 percent, while sales of new single-family houses are at the highest levels since March 2006.
Although the unemployment rate dropped sharply to 6 percent from 14 percent at the height of the Covid19 crisis, it is still above 2014 levels. The Federal Reserve and Biden administration will probably ignore the risk of inflation and let the economy overheat and cause inflation to rise.
It is generally accepted that the Fed would continue to buy long-dated government bonds to stimulate the economy and would refrain from tapering for quite some time. The feeding frenzy in the housing market must be a concern, though, and will probably cause banks to increase their mortgage rates despite being more willing to grow their lending books.
Turning points in US long-term interest rates, including government bond yields, inflation-indexed bond yields and mortgage rates, coincide turning points in physical holdings of gold in the gold-backed exchange traded funds (ETF) universe.
When long-term interest rates top out and begin to fall, investors flock to gold and vice-versa investors turn sellers of gold when interest rates bottom and rise.
Due to the significant correlation between the total gold holdings of all gold-backed ETFs and the gold price in US dollars, it is evident that investment demand for gold is the prime driver of the gold price in US dollars. My analysis indicates that an inflow of 100 tons of gold in the gold-backed ETF universe leads to a rise of 40 dollars (R570) per ounce in the price of gold.
As things stand, it is clear that US long-term interest rates have bottomed and are rising. The downward trend in the gold price in terms of US dollars is therefore likely to continue.
For the chartists, my analysis of the gold price indicates that the gold price is at a major point of resolve. A close above $1 784 by the end of the week could see a major move on the up, while a close below $1 721 could see gold testing major support at about $1 500. It could be a great opportunity for those boffins actively involved in the options market. All that in mind, I ask myself why I am still long of gold.
Investors have at long last become euphoric on the US equity market as measured by the S&P 500 Index. The CBOE Volatility Index (VIX), according to Wikipedia, a popular measure of the stock market’s expectation of volatility based on S&P 500 Index options, has now crossed 20 points (the neutral level between euphoria and fear) on the downside. During past business cycles, VIX remained below 20 points during major economic expansions and underscored major bull markets in equities.
A major worry for some investors is the high cyclically-adjusted price-to-earnings ratio or PE10, developed by Nobel Laurette Robert Shiller based on average inflation-adjusted earnings from the previous 10 years. The PE10 dropped to nearly 20 times earnings during the Covid-19 sell-off in March last year, but recovered to about 37 at the close on Friday – high indeed.
High tech sectors (communication and information technology) started to dominate the S&P 500 from 2014 onwards as the combined weighting of the two sectors increased to nearly 40 percent in the first quarter of this year from 26 percent in 2014.
The PE10 is likely to stabilise at current levels and may even drop somewhat as the US economy starts to fire on all cylinders and economically cyclical stocks’ weight increase. I think that the weight of tech stocks in the S&P 500 is likely to increase further in future, though, resulting in a continuation of the uptrend in PE19.
The equity market is not a bubble yet, but is still extremely vulnerable to so-called black swans – events that come as a surprise and have major effects on markets. Such events normally lead to investors switching from risk-on to risk-off strategies. It is particularly evident in gold’s performance relative to emerging markets. Gold significantly outperforms emerging markets when risk-off strategies are implemented. At this stage of the investment cycle and amid the vulnerability of gold to rising US bond yields despite rising inflation, I hold on to gold for those black swans. I prefer gold-backed ETFs above the geared gold shares, though.
De Klerk is analyst-at-large. Contact [email protected].com. He is not a registered financial adviser and his views expressed above are his own.
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