by Jurrien Timmer, Director or Global Macro, Fidelity Investments
Key takeaways
- Bitcoin partly usurped gold's traditional role of inflation hedge and store of value since the pandemic started. But with bitcoin correcting, the relationship between gold, real rates, and monetary policy may have been restored.
- Gold has closely tracked real yields, but in recent months the 5-year real yield has diverged from the 10-year. While gold has followed the 10-year, silver has followed the 5-year, which is more sensitive to Fed policy. That tells me that silver is functioning the way gold normally would have.
- Gold's underperformance could simply be the result of bitcoin taking market share from gold. But now that bitcoin is on correction mode, it may be time for gold and silver to shine as the reflation trade continues.
A funny thing happened along gold's traditional journey as a store of value during periods of monetary inflation: Bitcoin was created. As a result, over the past 15 months when gold should have shined, it was bitcoin that stole the show, taking market share from gold in the process.
But a closer look, in my view, suggests that the traditional role played by precious metals like gold and silver has not been broken. (Bitcoin is a cryptocurrency.) Rather, it has been only temporarily derailed. With bitcoin down 50% from its highs, gold is picking up where it left off, following real rates and monetary policy. Real rates reflect the interest rate after accounting for inflation.
The chart below shows a clear breakout from an 8-month consolidation. What appears to be happening is that gold is no longer moving in lockstep with the 10-year real yield, but is now catching up to the more bullish 5-year real yield. The chart below shows the 2 real yields in the bottom panel (reverse scale), as well as a simple regression model of where I might expect gold to be trading based on its past correlation to real rates. Gold seems to be following a new leader.
Why should there be a difference between the 2 real yields? As my colleague, Julian Potenza pointed out to me last year when the divergence first appeared, the 5-year real yield is more directly affected by Fed policy, given that both the Fed's forward rate guidance and asset purchases affect the belly of the curve more so than the long end. As a result, the 5-year is in the sweet spot of the reflation signal.
Why didn't gold just follow the 5-year in the first place? The simple answer, I believe, is that for many investors looking to hedge against monetary inflation resulting from the pandemic, bitcoin was a more appealing way to play it. But what's interesting is that while gold took a back seat, its sibling silver did not.
Check this out: If we overlay the price of silver onto the difference between what the 5-year TIPS model projected and what the 10-year model projected, we see a very close relationship (bottom panel below). This shows that silver has done exactly what gold was supposed to do!
Here is the pattern in a daily chart. It shows the price of gold against the 2 TIPS models (the projections are a bit different from the weekly chart because the regression periods are different).
Now let's overlay silver. Voila, we can see that over the past 15 months, silver has indeed played the role of gold, by following the 5-year real rate almost perfectly. Now gold is catching up to silver.
This tells me that gold's underperformance is not because it's a bad asset or because the narrative of monetary inflation has not been correct, but because bitcoin was probably cannibalizing gold's traditional role as a store of value. With bitcoin now under pressure, investors seem to be reverting to gold and silver.
My hunch is that both silver and gold are regaining control of the reflation narrative and may be ripe for a breakout. The chart of silver below shows a potentially bullish triangle, which would target $40 on a breakout above $30. For gold, the daily chart above suggests $2,200 at the current 5-year real yield of ā1.8%.
About the expert
Jurrien Timmer is the director of global macro in Fidelity's Global Asset Allocation Division, specializing in global macro strategy and active asset allocation. He joined Fidelity in 1995 as a technical research analyst.
