Gold has been trending lower since peaking at an all-time high of $2075 in summer 2020. However, there have been signs of growing recovery potential in recent weeks. It has been a slow burn, but now with inflationary forces building, the prospects of renewed positive momentum on gold are improving.
Inflationary forces are building.
The extremely strong relationship between gold, and “real” bond yields are helping to support gold.
The technicals imply a recovery into $1820/$1845.
Inflation is building
The Federal Reserve is adamant that increasing inflation is just “transitory” (or to the layperson, temporary). However, as revealed at the annual Berkshire Hathaway shareholder meeting, renowned long term investor, Warren Buffett sees it differently. “We are seeing substantial inflation…”
In yesterday’s ISM Manufacturing data, the Prices Paid component (ie. the input prices that producers pay to make goods) increased to its highest level since 2008.
Looking at commodity prices, it seems that Buffett may be right about inflation. Prices of some commodities are soaring. Soft commodities such as lumber have well over doubled in the past six months. Oil is over +80% higher and precious metals such as platinum are +45% higher. Also note in the chart, the underperformance of gold (but this is beginning to turn higher).
To gauge inflation expectations, traders look at markets such as the US 10 year forward breakeven inflation rate. Inflation expectations have moved to their highest since 2013. The important takeaway is that if this chart is rising it means that traders are pricing in more inflation.
However, this is negative for the outlook of “real” bond yields (the level of interest that bond traders receive once inflation has eaten away at their returns). Rising inflation when Treasury yields are consolidating means that in “real” terms, the returns that bond traders are worsening (“real yields” are falling).
Gold moves higher when “real” yields are falling
So why is this important for gold? The chart below shows a very strong and consistent negative correlation between gold and “real” bond yields. When real yields go down, this is positive for gold. Gold is seen as a store of value and a hedge against inflation.
As the chart shows, real yields have been falling for the past six weeks. This is coinciding with a rebound in the gold price. If real yields continue to fall then gold should continue to trade with a positive bias.
Near to medium term for gold outlook is improving
Looking at the technical analysis, Gold broke out above resistance at $1755/$1765 a couple of weeks ago. This completed a base pattern which implies $1745 potentially by the end of May. Relative Strength Index momentum is confirming this improvement too.
There seems to be resistance around $1797 to overcome, but if gold can begin to trade above $1800, we believe a run into $1815/$1845 will be seen.
Beyond that though is uncertain. There is a bigger downtrend at play, with a run of lower highs dating back to July 2020. This still looks to be a near to medium term recovery within a bigger downtrend. A bear market rally.
There is downtrend resistance and old key highs around $1855/$1875 to overcome for the move to be considered something decisively positive. For now, though, the prospects of a near to medium term recovery are improving. This is being helped all the more by rising inflation.