A Golden Equilibrium

Via Market Anthropology:

“As we mentioned in a note last month (see Here), the Federal Reserve Bank of San Francisco recently published an Economic Letter that argued by allowing inflation to overshoot the Fed’s 2 percent target, it would achieve the greatest decline in real yields and hence stabilize economic activity fastest (see Here). We would argue that what the Fed effectively did this week by discounting the firming US economic data and deferring to a general concern for the health of the global economy is shift their reaction function to a willingness to remain behind the curve on inflation. Hyperbole aside – it’s a rather big deal. 

And while markets have already been reflecting this shift in inflation expectations for several months as gold has predictably led the broader reflationary trend – to see the Fed bless this perspective should reinforce investors convictions that market conditions are shifting favorably towards supporting assets like precious metals, commodities and emerging markets that were left for dead as financial conditions tightened and real rates rose over the past several years.”

We concur with everything written above. The Fed loosened financial conditions this week by lowering the real 10-year Treasury yield by nearly 20 basis points. However, that’s the good news – the bad news for gold investors is that the yellow metal has essentially gone nowhere in the last month despite relatively extreme bullish sentiment, a decline in the US dollar, and a favorable macro backdrop:


Gold (Daily) with US Dollar Index above


While a declining US dollar and falling real yields offer a bullish backdrop for gold, this week’s inability to hold above $1260 is a yellow flag that should be noted. $1280 is resistance, $1230 is support, and for the time being price seems to have reached relative equilibrium between $1250 and $1260.