In the past few weeks, a coordinated barrage of hawkish comments by central bankers of some of the world’s most advanced economies have pushed long-term bond yields higher, clearly weighing on gold prices. At the annual ECB forum in Sintra, Portugal, President Mario Draghi talked about a strengthening and broadening global recovery supporting nascent reflationary forces in Europe. At the same conference, Bank of England Governor Mark Carney mentioned the possibility of removing monetary stimulus soon if economic slack continues to lessen, and Governor Stephen Poloz’s comments about absorbing excess capacity in Canada were perceived as a hint of an imminent rate hike, delivered last week.
The concerted effort, driven by growing optimism about a global economic recovery taking root after a lackluster 2016, had a noticeable impact on fixed income with global bond prices dropping markedly. Yields on 10-year government bonds have risen sharply in the US, Canada, Germany, the UK, Switzerland and even Australia, where the central bank has conspicuously refrained from joining the hawkish chorus. To be fair, this is of course due to the very high correlation among the advanced economy government bond markets as shown in the matrix below.
Sources: FRED, RBA, BoC, ECB, BoJ, SNB, BoE, author’s calculations
The sell-off in fixed income has been such that gold prices came off despite an initial drop in the US dollar, temporarily trouncing the long-term negative correlation between the currency and the precious metal. To some observers the move has been reminiscent of the “taper tantrum” in 2013, when former Chairman Bernanke’s announcement that the Federal Reserve would begin to reduce its purchases of Treasury bonds as part of its quantitative easing program drove 10-year Treasury yields from 1.66% in May to nearly 3% by September.
Despite the recent sell-off in bonds however, with the notable exception of 10-year US Treasuries global yields at present levels still appear consistent with significantly higher gold prices. To be sure this may simply be an indication that global bond yields are too low, especially when compared to US Treasuries, although by the same token narrowing interest rate differentials would suggest a weaker US dollar ahead. The table below shows linear and exponential correlations of the precious metal with a number of the major global bonds over the last 20 years, as well as the gold prices in USD that would be consistent with current yield levels. In particular, note that 10-year Canadian government bond yields, which are more highly correlated to gold than even US Treasuries, suggest gold prices at almost $1390 on an exponential basis. In the UK, although certainly highly influenced by even greater uncertainty emanating from Brexit, current levels on 10-year gilts are consistent with prices in USD at almost $1730.
