Resilient gold is supported by geopolitical risk

  • Historical tightly inverse correlation between gold (XAU/USD) and US Treasury 10-year real yield (TIPS) has started to wane in the past four weeks.
  • An uptick in geopolitical risk may be the factor that is supporting a resilient movement in gold despite higher 10-year TIPS.
  • Watch the US$1,940 key intermediate resistance on gold (XAU/USD) for a potential bullish breakout.

In the past week, a higher momentum movement is seen in longer-term sovereign yields over their shorter-term durations where the US Treasury 10-year yield recorded a weekly gain of 23 basis points (bps) over a meager return of + 5 bps seen on the US Treasury 2-year yield.

If we stripped out inflation expectations, the US Treasury 10-year real yield, derived from the 10-year Treasury Inflation Protected Securities (TIPS) yield has a higher momentum intensity over the US Treasury 10-year nominal yield.

US Treasury 10-year real yield has broken above its Oct 2022 major swing high

Fig 1: US Treasury 10-year real & nominal yields major trends of 11 Jul 2023 (Source: TradingView, click to enlarge chart)

Based on last Friday, 7 July closing prices, the US Treasury 10-year real yield increased to 1.79% and broke above its prior October 2022 key major swing high of 1.69% while the 10-year nominal yield rose to 4.07% but still below its October 2022 key major swing high of 4.22%.

Thus, given the higher positive momentum factor seen in the longer-term real risk-free interest rate; US Treasury 10-year real yield, the opportunity costs of holding other long-duration riskier assets in fixed income and equities have increased which reinforced their weak performances seen last week; iShares Investment Grade Corporate Bond ETF (-2.40%), iShares High Yield Corporate Bond ETF (-1.63%), and iShares PHLX Semiconductor ETF (-2.54%).

Interestingly, another “competing” asset, gold priced in US dollars (XAU/USD) did not record a similar magnitude of loss last week. In contrast, spot gold (XAU/USD) recorded a gain of +0.31% for the week ending 7 July.

The prior high degree of inverse correlation between gold and 10-year TIPS has waned

Fig 2: US Treasury 10-year real yield correlation trend with Gold (XAU/USD) as of 11 Jul 2023 (Source: TradingView, click to enlarge chart)

The correlation between gold (XAU/USD) and US Treasury 10-yield real yield (TIPS) tends to be tightly inversely correlated in the past ten years; when 10-year TIPS rose, the price of gold (XAU/USD) staged a decline and vice versus due to zero interest income earned from holding gold and as a hedge on US government bonds, as gold has no counterparty risk.

The 20-period rolling correlation coefficient between gold and the 10-year TIPS has been reduced to -0.60 from a recent high level of -0.84 recorded in early May 2023. What causes the current breakdown in the historical long-term tightly inverse correlation between gold and 10-year TIPS?

It is likely due to the geopolitical risk factor where the price of gold, acting as a safe haven asset tends to increase when geopolitical risk increases. Before the Russian invasion of Ukraine that occurred on 24 February 2022, in the prior two months, the high degree of indirect correlation between gold and 10-year TIPS have dissipated as both started to move in direct correlation.

Geopolitical risk has ticked up to an eight-month high

Fig 3: Geopolitical Risk Index as of 30 Jun 2023 (Source: MacroMicro, click to enlarge chart)

Based on quantified measures of geopolitical risk, the latest reading of the Geopolitical Risk Index (GPR) for the month of June 2023 compiled by US Federal Reserve economists Dario Caldara and Matteo lacoviello has started to tick up above the 100 level to 103.10, its highest level in eight months. The GPR measures the social mood of impactful geopolitical events, threats, and conflicts since 1985 by counting the keywords used in the press.

Watch the US$1,940 key intermediate resistance on gold (XAU/USD) for potential bullish breakout

Fig 4: Gold (XAU/USD) medium-term trend of 11 Jul 2023 (Source: TradingView, click to enlarge chart)

Thus, the recent resilient price movement of gold (XAU/USD) that has managed to hold at the US$1,913/1,896 key medium-term support despite the steep up move seen in the 10-year TIPS is likely attributed to an uptick in geopolitical risk.

Based on technical analysis, clearance above the US$1,940 key intermediate resistance sees the next resistance coming in at US$1,990 in the first step supported by a positive momentum reading seen in the daily RSI oscillator.

On the flip side, a break below the US$1,896 key medium-term pivotal support invalidates the bullish tone to expose the next support at US$1,856 (also the 200-day moving average).

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Kelvin Wong

Kelvin Wong

Senior Market Analyst, OANDA at OANDA
Based in Singapore, Kelvin Wong is a well-established senior global macro strategist with over 15 years of experience trading and providing market research on foreign exchange, stock markets, and commodities.

Passionate about connecting the dots in the financial markets and sharing perspectives around trading and investment, Kelvin Wong is an expert in using a unique combination of fundamental and technical analyses, specializing in Elliott Wave and fund flow positioning, to pinpoint key reversal levels in the financial markets.

In addition, over the last ten years, Kelvin has conducted numerous market outlook and trading-related seminars, as well as technical analysis training courses, for thousands of retail traders.