Sunday, June 1, 2014

Gold weakness is inconsistent with loose monetary conditions in the US

Gold has been selling off sharply recently.

spot gold (source: barchart)

Investors have been reacting to a number of factors which include the following:

1. The easing of tensions with respect to the Russia/Ukraine crisis - the so-called "Putin factor" (as discussed here).
2. Continued strength in US equity markets
3. The economic slowdown in China and increased tariffs on imported gold in India have reduced physical gold demand
4. The US dollar has been firmer recently, which is generally a bearish sign for gold and other commodities
5. Reduced fiscal and monetary policy uncertainty in the US (see chart)

In spite of all the headwinds for gold, one factor remains puzzling. US real rates have collapsed recently. The 5-year treasury real (inflation-adjusted) yield is now deep in the negative territory and the 7-year real yield is approaching zero. It means that those who hold 5-year treasuries right now are losing money after inflation is taken into account - even if treasury prices remain stable.

This is telling us that the monetary policy in the US has become even more accommodative - in spite of the Fed's taper.

Source: US Department of the Treasury

At least in theory, low or negative real yields make gold more attractive. And as US inflation picks up (see chart), real yields could move even lower. Moreover, if the ECB embarks on a new round of aggressive easing (see post), the euro area monetary stance will become highly accommodative as well.

The recent weakness in gold price is inconsistent with these looser monetary conditions in the US and potentially in the Eurozone. If you have a view on the topic, please answer this single-question survey. Results will be published shortly.
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