Gold Market Commentary: Can gold bear the bond steepener?

Yields take centre stage

August was challenging for gold. After dipping below US$1,900/oz, it staged a late recovery – around the Fed’s Jackson Hole annual symposium – to finish the month down 1% at US$1,942/oz (Table 1).¹ This slightly reversed July’s 3% gain and, in line with our expectations, bucked the historical trend of positive August returns.

Global gold ETFs saw another monthly outflow in August. Total AUM fell US$3bn (46t), with the majority coming from US listed funds. COMEX managed money net long positioning declined to an five month low, before ending the month at 181t.² OTC daily trading volumes remained elevated at US$143bn/day.

Our gold model GRAM suggests that changes in 10-year yields, the US dollar and COMEX futures positioning were key headwinds for gold in August (Chart 1). US 10-year Treasury yields hit a 16-year high during the month,³ fuelled by rampant speculation over a possible Fed re-assessment of the US neutral rate. The growing expectation for ‘higher for longer’ rates (above 4%) is, in essence, a reflection of how persistent inflation and economic resilience continue to be. Dollar strength, meanwhile, was likely supported by concerns over China’s housing market, as well as broad struggles in export-dependent currencies (such as Europe and China).

Gold found some support from the unexplained component of the model. As we have previously suggested, this could in part represent continued strength in central bank buying.

Table 1: Returns across currencies summary

Gold price and return in different periods across key currencies*

*Data to 31 August 2023. Based on the LBMA Gold Price PM in USD, expressed in local currencies. 
Source: Bloomberg, ICE Benchmark Administration, World Gold Council

Looking forward

• Recent changes in yields have led to a ‘bear steepening’ of the yield curve, historically a more challenging environment for risk off assets such as gold 
• But the expectation of a slowdown remains – a scenario in which gold has historically performed well.

Reading the curve

The US Treasury yield curve is arguably the most important financial indicator around, and its trajectory and shape are constantly under scrutiny. Most of the time (90%) it slopes upward as investors need to be compensated for lending their money for longer. ⁴ But at times, it inverts. As it has since July 2022, suggesting bond market participants have lapped up longer-dated Treasury bonds in anticipation of a dramatic economic and/or inflation slowdown as the ‘long and variable lags’ of monetary policy tightening kick in. 

The bear awakens

Despite a pick-up in energy prices and some positive economic surprises, the evidence that we are very late in the business cycle, with growth and inflation slowing, still dominates.⁵ At this late stage one would typically expect any steepening of the yield curve to be the result of short rates dropping faster than long rates – i.e. a ‘bull steepener’.

Instead, while the yield curve remains inverted, it experienced a fairly consistent ‘bear steepening’ from mid-July to mid-August,⁶ with long-dated rates rising faster than short rates (Chart 2). 

A bear steepener normally happens early in the business cycle or during a period of reflation. Bear steepeners tend to be bullish for risk assets and more challenging for hedge assets like gold, especially during ‘bear +’ periods (a subset of a bear steepener) where long and short rates are both rising together (Table 2).

*Yield curve phases represented by 10-year less 2-year Treasury yield spread. The top two rows shows the dominant driver of the shift in the curve, represented by the larger arrow. The table below shows the annualised average returns for four major asset classes during each mutually exclusive phase, as well as the share of the phase returns that are up. The data is from Dec 1971 to July 2023 on a monthly frequency. Equities: MSCI world index, Bonds: US Government bond index, Commodities: BCOM index, and gold in US$/oz.

Source: Bloomberg, World Gold Council

On 2 August, the US Treasury announced US$1.9 trillion of issuance required to meet liabilities. It had prompted the ratings agency Fitch to downgrade US debt from its AAA rating to AA+ the day prior. While it has largely been dismissed as having little immediate bearing on bond markets, it has raised the narrative of ‘fiscal dominance’.⁸ This is particularly concerning as the federal budget deficit comes at a time when unemployment remains low.⁹ 

Alongside the expected bond supply increase, there are signs of demand fatigue as well: a lack of buyers at the 10 August auction saw 30-year bonds ending up in the hands of primary dealers.¹⁰ 

In addition, actual and expected sales of Treasuries by the two largest international holders –Japan and China – could be influencing sentiment. For example, the announcement by the Bank of Japan that it would raise its yield curve control (YCC) cap has made local JGBs more attractive relative to their US counterparts. And while there is little evidence of capital flowing back yet, the strength of the Japanese economy suggests they will only get more attractive. 

2. Risk assets not following playbook

The cross-asset implications have not been typical either. While gold has played to the tune of the bear steepener, falling 2% since July 20th, equities and commodities have not. Global equities are down and commodities ex oil are flat. These assets don’t appear to be buying the risk-on story.¹¹

What’s next

In summary, the move in the 10-year yield can likely be attributed to three main factors. A shift up in the ‘higher interest rates for longer’ narrative, supply and demand forces and a rise in the risk premium. The latter factor might start to provide support to gold prices, if it continues to increase.¹²

If we simply look at bear steepening, gold tends to underperform – with low single digit average returns. Historically, the most likely successor to a bear steepening is a bull flattening (approx. a third of the time).¹³ This is characterised by a fall in the long end of the curve relative to the short end, effectively an unwinding of the rising premia we’ve witnessed. This partly took place at the latter end of August with gold likely benefitting from such yield declines. Also, soft data continue to suggest that a slowdown is still firmly on the cards. This could result in either a bull steepening or a rare ‘bear-‘. Both phases have on average been gold friendly, yielding an annualised return of 15% – the highest of all the phases.

Regional insights

China: Local wholesale gold demand picked up – reflected by a 22% m/m rise in August’s average daily Au9999 trading volume. The rebound was mainly helped by the Chinese Valentine’s Day during the month, when retailers usually increase their promotional efforts. Upcoming major jewellery fairs in September also spurred replenishing activities. Gold ETFs attracted Chinese investors’ attention, adding 5t amid their downbeat sentiment on weaker-than-expected economic recoveries and lousy equity performances.

US: Remarks from Fed Chair Powell at Jackson Hole did little to steer market thinking in one direction or the other. Mixed macroeconomic data continues to support the ‘higher interest rates for longer’ narrative, which may have resulted in heavy gold ETF outflows, but the lagged effect of tighter policy to date cannot be ignored. US Eagle coin sales jumped to 85,500oz in August, the highest sales volume since May (Chart 4).

Europe: The economic outlook for the region continues to deteriorate, as manufacturing activity has fallen to levels not seen since the Global Financial Crisis. The European Central Bank faces a tricky balancing act in bringing inflation down – President Lagarde stated interest rates will stay high for “as long as necessary”¹⁴ – while not pushing the region’s economy into deeper trouble.

Central banks: Latest data available shows that global central banks added 55t to their gold reserves in July. The People’s Bank of China and the National Bank of Poland both added around 23t, while the Central Bank of Turkey was again among the buyers (17t). Qatar (3t), Singapore (2t) and the Czech Republic (2t) also bought gold. The Central Bank of Uzbekistan (11t) and the National Bank of Kazakhstan (4t) were the two noteworthy and familiar sellers in the month.

ETFs: Physically-backed gold ETFs¹⁵ experienced net outflows for the third straight month, losing US$3bn in August.¹⁶ Total AUM fell 3% to US$209bn whilst holdings saw a 46t decline, to 3,341t.

The majority of loss came from North American funds, extending their losing streak to three months. Europe also saw negative flows for the third consecutive month. But August’s outflow was markedly narrower than July’s US$1bn. In sharp contrast, Asian funds led global inflows, with China contributing the most (+US$293mn, +5t). Flows in the Other region were little changed, adding US$24mn.

1. Based on the LBMA Gold Price PM in USD.

2. As of 29 August 2023.

3. Bloomberg

4. Among other factors are risk premia and inflation expectations.

5. Slowing economic activity, contracting credit, falling corporate sales and earnings.

6. We use the difference between the 10-year Treasury yield and 2-year Treasury yield as two of the most liquid issues to capture the shape of the bond yield curve.

7. We regressed the change in the US 10-year yield on the change in the January 2025 Fed funds futures (the longest maturity on the WIRP function in Bloomberg) and the R-squared was 0.48.

8. Brad Setser

9. Morgan Stanley

10. Bloomberg

11. A wall of weak China macro data was probably the main cause of a commodity slump.

12. It could be argued that gold is simply responding to a rise in 10-year yields, real and nominal, and the curve is less important. We would counter that the curve, rather than a particular yield, is important when monetary policy is dominating the narrative or is in transition. As we showed in May, gold has been correlating with the 2y as much as the 10y, hence indirectly taking cues from both yields. That by extension should mean the yield curve does matter, at least for now.

13. Using monthly data from December 1971 to July 2023 on US 10-year and 2- year Treasuries and the respective spread.

14. AP News

15. We define gold ETFs as regulated securities that hold gold in physical form. These include open-ended funds traded on regulated exchanges and other regulated products such as closed-end funds and mutual funds. A complete list is included on the gold ETF section of Goldhub.com.

16. We track gold ETF assets in two ways: the quantity of gold they hold, generally measured in tonnes, and the equivalent value of those holdings in US dollars (AUM). We also monitor how these fund assets change through time by looking at two key metrics: demand and fund flows.

• Gold ETF demand is the change in gold holdings during a given period. We use this metric to calculate the quarterly demand estimates reported in Gold Demand Trends.

• Fund flows represent the amount of money – reported in US dollars – that investors have put into (or retrieved from) a fund during a given period.
  For more details, see our ETF methodology note.