Gold futures soared last week, helped by a plunge in the U.S Dollar against a basket of currencies to its lowest level in 2-years. The dollar was driven lower by falling U.S. Treasury yields as investors priced in the need for more fiscal and monetary stimulus.
Weak U.S. economic data, led some to predict a much steeper recession than previously thought and a surge in the Euro after the European Commission (EU) agreed to a massive stimulus measure, contributed the most to the dollar’s decline and gold’s strength.
The move in gold also suggests investors are betting on a much weaker U.S. economy. The current economic conditions and stimulus discussions indicate the U.S. government and Fed are going to have to support the economy until the coronavirus is contained. This move could bankrupt the economy, further weakening the U.S. Dollar and increasing dollar-denominated gold’s appeal to foreign investors.
A number of factors may have driven investors into the gold market last week, but the two main influences on the sharp rise in prices were the falling U.S. Dollar and record low interest rates. The main reasons behind these moves were the EU stimulus deal and expectations of more U.S. fiscal stimulus.
EU Leaders Strike Massive $2 Trillion Deal to Rebuild Europe’s Economy
After nearly five days of intense discussions, European leaders agreed to create a 750 Euro ($858 billion) recovery fund to rebuild EU economies devastated by the coronavirus crisis.
The European Commission will borrow the money on financial markets and distribute just under half of it – 390 billion Euros ($446 billion) – as grants to the hardest hit EU states, with the rest provided as loans. Leaders also agreed a new EU budget of nearly 1.1 trillion Euros ($1.3 trillion) for 2021-2027, creating combined spending power of about $1.8 trillion Euros ($2 trillion).
“It is an ambitious and comprehensive package combining the classical [budget] with an extraordinary recovery effort destined to tackle the effects of an unprecedented crisis in the best interest of the EU,” the EU leaders said in joint declaration.
Plunge in U.S. 10-year Yields Increasing Gold’s Attractiveness
The announcement of the EU deal may have lit the fuse in the gold market last week, but it was the fall in U.S. 10-year yields that launched the huge rally.
Although most novice gold investors seem to be hooked on buying gold during times of crisis and uncertainty, safe-haven demand has little to do with the real reason why professionals are buying gold.
At this time, the negative correlation between long-term U.S. real yields and gold futures is holding up very well. This is because when long-term U.S. real yields decrease, gold becomes more attractive even though it doesn’t pay interest or a dividend.
In other words, investors are saying Treasurys are paying virtually nothing and with gold also paying nothing to hold it, the opportunity cost of gold is virtually zero. So why not buy it and bet that gold will become more valuable then holding government paper.
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