Gold Insights: The Burst Bond Bubble Spells Trouble

| About: SPDR Gold (GLD)

Summary

Bonds have decisively sold off.

Dollar continues to march higher.

If this trend lasts, higher yields and stronger dollar will be decisively negative for gold.

Various markets across asset classes have reacted strongly following the election. However, the way the markets have reacted has been completely counterintuitive following the November 8 election results. Those hedging for the possibility of a Trump presidency did so by going long gold, short equities, long bonds and short the U.S. dollar. These hedges worked in a way which was expected... for about three hours...

The market has a funny way of making a fool out of even the most sophisticated investor. What has transpired from November 9th and onwards goes to show this. Equities have rallied hard, bonds have collapsed decisively and the U.S. dollar is at a new 52-week high. As for gold, I am preparing for the distinct possibility that gold may be entering a bear market.

There are two data points which have me particularly concerned when it comes to gold, these being rates and the U.S. dollar. As you know, both highly correlated with gold and help explain a majority of moves in gold.

The chart below shows just how violently 10-year yields have moved over the past month.

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Now this reflects the nomimal yield, and nominal yields alone are not all that great at predicting the moves in gold (NYSEARCA:GLD). Real yields (yields adjusted for inflation) on the other hand are what really drive gold, because of the age old argument you have all heard: "gold doesn't pay a yield". Therefore, when real yields are negative, it pays to own assets such as gold which retain their value versus cash. Now with inflation still remaining low, a move in nominal yields affects real yields. The chart below shows what the move in nominal yield has done to real yields. For your reference, real yields are calculated as 5 year nominal yield minus 5 year break-evens.

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As you can see, when real yields are moving higher, gold tends to perform poorly. However, while this movement is not 100% correlated, it is highly correlated, because there are two other factors which help gold, namely volatility (any large asset class) and currency, which in this case is the U.S. dollar.

The U.S. dollar has strengthened considerably following the elections because the market expects Trump's policies to be negative for emerging markets and global growth.

The chart below shows the strong move we have seen in the U.S. dollar, a move which has carried it decisively to a five year high.

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So what does this all mean as far gold goes? Put bluntly it's a "Mayday" for gold. Gold's denominator, the U.S. dollar, is getting stronger, while gold's driving force, which are low/negative real yields are moving higher as well. What is stopping me from throwing in the towel on gold is the plain fact that the move in both the dollar and the yields has been very impulsive and sharp. Moves of this sort often fizzle out and revert to the mean. Those long gold, and there are many based on the total ETF holdings of gold and futures, are hoping for just this to play out. For what it's worth, on my dashboard, the light for gold has gone from green to bright yellow.

Disclosure: I am/we are long SLV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.