Nov 08, 2019
There are few more bearish signals than a failed breakout to the upside and the sell-off in precious metals this week is a perfect example. Gold broke its low of 1465 on October 1 to reach its lowest level since August 2.
Silver fared likewise, reaching its lowest level August 13.
On a more positive note, the miners have been more resilient. They lagged the metals on the final move higher in late August, early September, and now they’re lagging on the downside. This reinforces the view that this is the final dip before a rally to new highs next.
Much of this move down in metals is being driven by what is happening in the bond market. Correlations come and go and that makes them unreliable. But there are those correlations that persist over time, despite clear breakdowns for short periods. The relationship between Gold and real yields, or their proxy, Treasury Inflation Protected Securities (“TIPS”), is just such a correlation.
Currently in the 90s, the correlation between TIPS and Gold is near perfect. As the chart shows, the correlation does break down but the two come back together over time. Typically, it is Gold catching up with TIPS. This makes sense given that the size of the Treasury Bond market which is like Goliath to Gold’s miniaturized David. It dwarfs the equity market also. Given the near perfect correlation between TIPS and Gold, it makes sense to evaluate TIPS to help determine where Gold is headed.
TIPS’ price is the inverse of real yields, meaning when the latter fall, TIPS rise, and vice-versa when real yields rise. Real yields are basically nominal bond yields less inflation:
Real Yield = Nominal Yield – Inflation
In simple terms, if a 10-Year Treasury Bond (“10Y”) is 2% and inflation is 2.5%, real yields are negative 0.50% or 50 basis points. If inflation is 1.75%, the real yield on the 10Y is a positive 25 basis points.
10Y Nominal Yield > Inflation = Positive Real Yield
10Y Nominal Yield < Inflation = Negative Real Yield
More importantly for Gold, when real yields are rising, the prices of TIPS and Gold fall. And when real yields fall, TIPS and Gold rise.
Official inflation numbers have been relatively stagnant recently which means that real yields are primarily derived from nominal bonds yields.
Back in early October, I tweeted the following:
The 10Y yield has reached my minimum target of 1.98% for wave C where the size of wave C = wave A. The top could be in for nominal and real yields here. Alternatively, wave C could be as much as 161.8% of wave A which would put the top at 2.28%, or anywhere in between.
Looking at TIPS directly, we still have some work to do on the downside to hit ~114 for wave C = A.
My preferred targets on the downside in Gold and Silver are still the low 1420s and 16.50, respectively. I’m happy to leave a few pennies behind given what’s coming and will wait for the turn up to begin before buying the dip.
The alternative in Gold is a move down to 1340-1360 before higher again. This is where we see convergence of the megaphone pattern on the chart below, the peak back in February, and trendline support since the bottom in August last year. ~1340 is also the 76.4% Fib of the rally since the low in May. 1367 is the 50% Fib of entire move up from 1167 last year.
This is currently a low probability event and would be a gift if it happened.
The overall point is we are closer to the peak in yields and the bottom in Gold and therefore Silver and the miners too.