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Gold Price Correlation with Treasury Yields Back In Fashion

Commentaries & Views

Gold prices were hammered on Tuesday breaking through key support as higher U.S. treasury yields buoyed the U.S. dollar, which weighed on gold prices. Hedge funds are long gold and are likely liquidating positions on this move.  Historically the correlation between gold prices and treasury yields are negative and this path will like resume if yields continue to break out.

Gold and Treasury Yields are Moving in the Opposite Direction
Gold prices are breaking down just as the 10-year U.S. treasury yield is breaking out.  U.S. yields are on an upward trajectory as the Fed is normalizing interest rates.  Economic data has been mixed and inflation has been subdued yet the Fed seem to be on a set path of raising rates. Any positive data points are proving to be a catalyst for rising yields.

The chart of gold versus the 10-year treasury yield shows that yields are breaking out and gold is breaking down.  The picture shows that most of the time gold and yields move in opposite direction.  Over the past 10-years, there was a significant divergence in gold prices and yields in 2012 and 2013 as well as in 2016.  Additionally, the historical movements are on average negatively correlated. (As a reminder: correlation is a study that shows if two or more assets move in tandem.  Perfect correlation is 100% (or 1) and perfect negative correlation (two assets move in opposite directions) is -100%.)

The average negative weekly correlation between gold prices and U.S. treasury yields is approximately negative 50%, with a low of negative 80% and a high of 3%.  Most of the time the correlation is negative, but the recent consolidation in both gold and treasury yields has led to a random correlation coefficient of zero. The recent breakout in treasury yields and breakdown in gold prices should lead to greater negative correlation between gold prices and treasury yields.

Hedge Funds are Long Gold Futures and Options
According to the most recent commitment of trader’s (COT) report released for the date ending May 8, 2018, hedge fund traders reduced long position in futures and options by 10.4K contracts while also reducing short positions in futures and options by 11.1K contracts of futures and options

The report shows that open interest that is long futures and options outnumber open interest that is short-futures and options by nearly double 118K to 65K.  The decline in prices this week likely led to a further liquidation of long futures and options in the managed money category.

The Seasonal factor
A seasonal study of gold prices shows that gold returns are generally lower to unchanged in the latter part of spring, which includes May and June. The average return for May over the past 20-years shows that gold prices are lower 50% of the time with an average decline of -0.3%. The average return for June show that gold prices are lower 55% of the time with an average decline of -0.3%. Gold usually shows its best performance in April and has its worst performance in October.

The technicals
Gold prices broke down through trend line and horizontal range support and is likely to now find itself in a different range capped near 1,300 and floored near the December 2017 lows at 1,240. Prices are not yet oversold as reflected by the relative strength index (RSI) that is currently printing a reading of 33.3.  A drop below 30 would reflect that prices are oversold and could foreshadow a correction. Momentum is negative as the MACD (moving average convergence divergence) recently generated a crossover sell signal. The MACD histogram is printing in the red with a downward sloping trajectory which points to lower prices.

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