As 2021’s first quarter comes to an end, gold hasn’t enjoyed a great time of it. The precious metal has tumbled 19% from its high last August and is back where it was in February of last year, before the pandemic hit the developed world.

Gold did at least manage to rally in Wednesday trading, as traders took heart from its ability to stop short of the 20% fall that would have qualified as a bear market. But the problems for gold are still significant, and come as something of a surprise. Last August, I wrote a Points of Return on the gold price, which looked at various arguments by analysts and concluded that “absent a swift victory over the virus, all of these... methodologies suggest that there is far more room for gold to rise than to fall.”

Progress in the fight against the Covid has arguably been better than expected since then. The third wave that hit the U.S., and the second wave in Europe, shattered hopes that populations might already be close to “herd immunity,” but progress in producing vaccines has been far faster than expected then. This has, as predicted, made the environment less favorable for gold. Still, the extent of the decline requires some explanation. 

First, and most important, this has been the worst quarter for bonds in some decades. These facts may well be related.

Not even the Federal Reserve’s insistence that it will keep financial conditions as lenient as possible has been enough to keep longer-dated bond yields down. As a result, the Bloomberg Barclays Treasuries index has fallen more than 4% for the quarter, the first time this has happened since the first and third quarters of 1980, when stagflation was at its height.

The assumption in the market, correct or otherwise, is that more inflation is coming down the pike, and that the Fed will have to raise rates in due course to deal with it. What is interesting is exactly when inflation will arrive; that has important implications for gold. Although the metal is regarded as an inflation hedge, it isn’t as simple as that. It is more sensitive to interest rates. When rates rise, because of fears of long-term inflation, gold can be expected to fall. Hence, the price has taken a horrible tumble even as markets brace for inflation. 

John Higgins of Capital Economics Ltd. in London produced implicit performance for the real yields of notional zero-coupon two- and 10-year bonds. Normally, they track each other, but they have parted company dramatically this year, reflecting the belief that the Fed will be lenient for a while (keeping short rates low), and will have to intervene more strongly with higher rates in the longer term. Gold, unfortunately for investors, follows longer-dated bond yields:

There are reasons for this. Gold yields nothing and lasts forever, so should be treated like a zero-coupon long-duration asset. Higher rates make its lack of yield more unappealing. Low rates make it look better. The lowest real yields in history, as seen last year, were enough to bring the metal to an all-time high in nominal terms. So it shouldn’t be that surprising that, with real yields rising this quarter, the gold price fell. 

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