Tuesday's Market Minute: Inflation, Rates, And Gold

The U.S. and global economies are surging back from the pandemic. Unemployment is dropping, lockdowns are less restrictive, and the demand for investment and consumption are on the rise. These factors alone are a recipe for strong growth, higher interest rates, and a stable dollar as economies in the rest of the world follow the U.S. with their own reflation narrative. Despite these factors, the U.S. Dollar traded at a six-week low versus major peers yesterday, and Treasury yields hovered near their weakest in five weeks. As one would expect, oil prices edged higher supported by a weaker U.S. Dollar, but prices seem stuck in a 5-year average range between $50 and $70 per barrel.

With inflation expectations rising, bond investors command a higher interest rate premium. However, if you compare the rise in rates to the decline in gold prices, there is a high degree of inverse correlation. The yield on the 10-year has risen from 0.92% in early January to 1.6% yesterday. Looking at a chart of gold futures year to date, the precious metal traded from a January high of 1,960 down to 1,775 per ounce yesterday. Rates are rising because there is a high degree of investment demand and a surplus of household savings fueling that demand.

Since the economy is not operating at full capacity in both labor and capital, as rates go up, gold goes down, signaling a normal interest rate condition relative to potential GDP and not the runaway inflation many fear is right around the corner. Some investors view gold as a hedge against higher inflation that could follow more stimulus measures, but higher Treasury yields dull some of that appeal for the non-yielding commodity. Investors should remember that gold does not pay interest and it has underperformed stocks over time. Over the past 10 years, gold has risen by 22%, and the broad S&P index has nearly tripled.

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