• Spot gold continues to stick within a few dollars of its 21-day moving average within a tight mid-$1720s-mid-$1740s range.
• The precious metal has been caught this week between the conflicting forces of a strong USD but lower real yields.

Spot gold prices (XAU/USD) continue to stick within a few dollars of its 21-day moving average, as has been the case for pretty much the entire week, during which time spot prices have been locked within a tight mid-$1720s-mid-$1740s range. On the day, spot gold prices trade a modest 0.3% higher while on the week, they are about 0.7% lower.

Driving the week

Spot gold is about to post its least volatile week in months, with the precious metal having been caught between two conflicting forces. On the one hand, the US dollar (to which gold is negatively correlated) has been on the front foot, with the DXY rallying from under 92.00 to current levels in the upper 92.00s.

On the other hand, bond market price action has been much more precious metal favourable; real US bond yields have declined this week, with the 10-year TIPS yield dropping about 8bps from around -0.6% to closer to -0.7%. Meanwhile, nominal yields have also fallen, but by a less significant amount, meaning inflation expectations have risen even further – 10-year break-evens are currently in the mid-2.30s%, their highest levels since early 2014.

Remember that 1) precious metals like gold typically have a negative correlation to real yields and 2) precious metals like gold are seen as a hedge against inflation, so rising inflation expectations tend to be gold positive. That means the combination of lower real yields and higher inflation expectations this week has prevented XAU/USD from being battered by the rallying USD.

Thoughts on Covid-19 third waves and gold

In recent weeks, the general trend has been for both USD and bond yields to move higher in tandem with each other, mainly as a reflection of optimism about the US economy and the hawkish implications this eventually has for Fed policy. But the narrative appeared to shift a little bit over the past seven or so sessions. It’s been less about optimism about the US recovery and more about concerns regarding third Covid-19 waves in Europe and other parts of the world; this is the main reason why global equities have pulled back (if only very modestly) from recent highs and why crude oil has corrected sharply lower.

There are nascent signs of a third wave in the US also (the 7-day moving average of new Covid-19 cases is up nearly 10% in the last week). While it is hoped that the fact most vulnerable US citizens having been vaccinated already ought to keep the death toll of any third wave in the US low, a pickup in cases is likely to trigger some concerns. A more prolonged period of risk-off is likely to play into USD and US government bonds’ properties as safe-havens, meaning a higher USD and lower yields.

Such an environment would likely continue to confuse gold, but key risk events next week, including the release of US March ISM manufacturing PMI on Thursday and the US March NFP report on Friday could help to break the precious metal from its slumber.