The Biggest Reason to Buy Gold Is Disappearing

Tame inflation and a gradual rise in Treasury yields have put a temporary damper on gold. | Image: REUTERS/Toby Melville/File Photo

• Gold price edges closer to three-and-a-half month lows.
• Core PCE came in at 1.3% annually in the third quarter, well below the Federal Reserve’s 2% target.
• The relationship between real interest rates and inflation holds the key to gold’s bull market.

The price of gold continued to weaken on Wednesday, as tame inflationary pressures undermined one of the biggest reasons to hold the precious metal: Inflation rising faster than real interest rates.

Precious Metals Under Pressure

The precious metals market continued lower ahead of Thanksgiving holiday, as appetite for risk capped gold and silver.

February gold futures declined 0.5% to $1,459.70 a troy ounce on the Comex division of the New York Mercantile Exchange. The yellow is targeting the November low of $1,453.70. A break below that level would send prices toward four-month lows.

Silver prices dumped 0.8% to $17.03 a troy ounce in New York trading. The grey metal was last seen hovering around $17.03 an ounce.

Gold’s premium over silver strengthened marginally on Wednesday, climbing 0.2% to 85.66 ounces.

Precious metals were also being pressured by a stronger U.S. dollar, which rose 0.2% against a basket of competitor currencies.

PCE Undershoots Fed Target

The U.S. economy grew faster than initially forecast in the third quarter, but underlying inflation continued to undershoot the Federal Reserve’s target – undermining one of gold’s biggest value drivers.

Gross domestic product (GDP), the value of all goods and services produced int he economy, grew at an annualized rate of 2.1% in the third quarter, the Commerce Department reported Wednesday in a revised estimate. Government economists had initially reported growth of 1.9%.

The core personal consumption expenditure (PCE) index – a key measure of inflation – rose just 1.3% annually over the same period. That’s unchanged from the prior estimate.
At just 1.3%, underlying inflation is undershooting interest rates by a considerable margin. U.S. government debt yields rose on Wednesday, with the benchmark 10-year yield peaking at 1.78%. Yields rise as bond prices fall.

The yield curve has been trending downward for the past 12 months and has fallen below several key measures of inflation, such as the consumer price index (CPI) and core CPI. But the core PCE is the Fed’s preferred guidepost for inflation, so investors may put more emphasis on this metric.

If interest rates continue to fall, as they’re expected to do, the yield curve could undershoot core PCE in the not-too-distant future. Such a move could ignite another rally in gold prices.

With the Federal Reserve slashing interest rates three times since July, there’s strong reason to believe that inflation will make its way to the real economy. The counter-argument is that quantitative easing and low interest rates have caused deflation because capital is being hoarded by financial institutions and not making its way to the real environment. In this environment, the velocity of money decreases, leading to weak underlying inflation.