Trumpflation Might Not Help Gold if Real Rates Keep Rising

Gold bugs are caught between a shiny rock and an asset inflation can't debase.
Photographer: Lisi Niesner/Bloomberg

What's happened to gold?

Conventional wisdom held that the uncertainty that would follow a Donald Trump victory in the election would be very positive for safe-haven assets like gold, but since Nov. 8 the shiny stuff has fallen by more than 6 percent to below $1,200 per ounce.

XAU Curncy (Gold Spot   $_Oz) Li 2016-11-23 09-25-57
Source: Bloomberg

And if gold's a hedge against rampant inflation, wouldn't the imminent installment of the inflation president also prove a boon?

That may be because although fears of (in/de)flation, the disintegration of civilization in general or the European Union in particular, food prices, investor sentiment, and bets on monetary disorder have all taken their turns in being cited as the key factor in gold investment theses, the behavior of real rates has proved far more important in explaining bullion's gyrations.

Following durable goods orders for October that more than lived up to their name and dispelled any notion of election-related uncertainty restraining business activity ahead of the event, the yield on five-year Treasury Inflation-Protected Securities (or TIPS) broke into positive territory, hitting levels not seen since March 16, as gold tumbled.

USGGT05Y Index (US Generic Govt  2016-11-23 09-37-45
Source: Bloomberg

Such an observation is hardly novel.

Eddy Elfenbein, portfolio manager at AdvisorShares Investments LLC and founder of Crossing Wall Street, has built a model predicting where gold prices will go based on the deviation of short-term real interest rates from their natural level. The Globe and Mail's Scott Barlow has also explained the relationship between the two assets on a number of occasions.

The thinking here is that the value of a hard asset with a yield of zero (net of storage costs) will be affected by the relative real yield on assets that are considered risk free, an alternative holding. In other words, the so-called opportunity cost of buying gold rises as real Treasury yields increase.

So if you want to know how the president-elect is changing the outlook for gold, looking at inflation-protected Treasury yields instead might prove more useful than searching for nascent signs of Trumpflation.

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