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  • Rising real US bond yields have put downwards pressure on precious metals such as gold.
  • XAU/USD has slipped back towards the $1900 level, but rising inflation expectations could act as supportive.

Coming within a few dollar of November 2020 highs just above $1960 in the early part of Wednesday’s European session, spot gold prices (XAU/USD) have declined back towards the $1900 level in recent trade. The psychological nature of the $1900 level, as well as support in the form of 21, 28 and 31 December 2020 highs between $1900-$1906, is acting in support of the price action for now. Spot prices currently trade around $1905 and with losses of over 2.0% or more than $40 on the day.

Broad losses are being seen across precious metal markets; spot silver (XAG/USD) is 2.4% lower, spot palladium (XPD/USD) is nearly 1.5% lower and spot platinum (XPT/USD) is 1.2% lower. Precious metals appear focused on bearish impulses coming from 1) a rise in US nominal and real yields and 2) a rise in the US dollar.

Spurring bond market and USD price action on Wednesday has been the news that the Democrats managed to secure control of Congress by winning both available seats in Tuesday’s Georgia Senate elections (handing them a majority in the Senate to go with their majority in the House). Markets are betting on higher US fiscal stimulus in the months ahead as a result, hence higher bond yields.

However, there are strong arguments as to why in the months ahead, higher US fiscal stimulus might actually end up hurting USD and helping precious metals. Gold bulls may be keen to buy Wednesday’s dip.

Gold sold as bond yields move higher

Greater fiscal stimulus from a Democrat-controlled Congress means more US government debt issuance, which has put downwards pressure of US government bond prices and thus put upwards pressure on US bond yields. US 10-year yields are currently 8.6bps higher on the day to 1.041% (above 1.0% for the first time since February 2020) and the 2s10s spread (and approximation for the steepness of the US yield curve) rose by 6bps to 89.8bps, its highest level since mid-2017.

Meanwhile, real US yields (nominal yields minus inflation expectations) also saw decent move higher; after falling below -1.1% to fresh all-time lows at the start of the week, the 10-year US TIPS rallied as high as -0.998%, although is substantially off highs and currently trading just to the north of the -1.05% mark. But that is still nearly 4bps above Tuesday’s closing yield of -1.086%.

The move higher in real yields, combined with modest upside in the US dollar, appears to have been a particularly bearish factor for precious metals markets. As a reminder, when real yields on US government debt rise, that increases the incentive to hold US government debt as opposed to non-yielding precious metals.

Longer-term gold bulls to but the dip?

Though rising yields have put some downwards pressure on gold and other precious metals on Wednesday, longer-term bulls are likely to be holding tight for now. One reason to do so is that inflation expectations continue to rally; 10-year break-evens (the difference between nominal and real US 10-year yields) surged above 2.0% and are currently sat around 2.05%. 2018 highs just above 2.20% do not seem far off, given the more than 30bps rally since the start of December.

Higher inflation expectations make sense given recent developments; higher fiscal stimulus spending will increase inflationary pressures via the demand channel. Meanwhile, this higher spending is going to be funded by higher deficits, which will lead to higher trade deficits, both of which are likely to have a negative impact on the USD, which could add to inflationary pressures via the supply channel (i.e. imports becoming more expensive).

With precious metals seen as the “ultimate inflation hedge”, surging inflation expectations stand to be a positive for metals like gold. However, the precious metal complex might well have to go through some more near-term pain if real yields continue to rise.