Gold's debasement trade needs a Fed that blinks, and this one is hiking
Gold is down about 6% in September to $4,280, 23% below January's record, as the 10-year Treasury yield tops 5%. Central-bank buying sets a floor, but it does not set the price. Silver near $65 is the better-supported metal.
The case for gold this year has been a case about governments losing control of their debts. August seemed to prove it. September has challenged it. Gold rose 13% last month on fears about fiscal dominance, then gave back about half of that in three weeks as the US 10-year Treasury yield climbed to its highest since 2007. The debasement trade works when central banks are seen to be accommodating. The Federal Reserve is tightening, and gold will struggle to reclaim $4,500 while it keeps doing so.
Gold traded around $4,280 an ounce on Friday, heading for a weekly loss of more than 2%, according to the USAGOLD daily report. Silver was steadier at about $64 to $65. Both are a long way from January, when gold set a record of $5,589 on January 28 and silver hit almost $122 a day later before collapsing by roughly 30% intraday when the exchange raised margins. Gold is now 23% below its peak and silver 47% below.
The August rally shows what drives the marginal buyer. The World Gold Council says gold ended the month at $4,563, its third-best monthly return in a quarter of a century. Global gold ETFs took in $18 billion, the second-largest monthly inflow on record, and European funds had their biggest month ever. The council tied the flows to two official acts: the joint US-Japan yen intervention on July 31, and the Treasury's August 19 decision to double its buybacks of long-dated bonds after 10- and 30-year yields hit 20-year highs.
Both looked like governments leaning on markets to hold down the cost of their debt. Investors reached for the asset that nobody can print. The trade rests on an assumption: that authorities would choose cheap money over price stability when forced to pick.
The Fed has now picked. On September 16 it raised its target range to 3.75% to 4%, its first increase since 2023, and 16 of its 18 officials expect at least one more. Governor Michael Barr said this week that "further policy adjustments are likely to be needed," and New York Fed President John Williams called another hike by year-end possibly appropriate. Business activity is growing at the fastest pace in five years, input costs are rising at the steepest rate in four and Brent crude is above $100 on the Iran conflict. Treasury yields are responding to that, and gold is responding to the yields.
The arithmetic is simple. A 10-year Treasury yielding about 5.15%, just off Thursday's 19-year high of 5.22%, pays more than $50,000 a year on $1 million. Gold pays nothing. At 3.5% yields the forgone income was small enough for a fiscal scare to swamp it. At 5%, the holder needs to believe that the metal will rise by about that much every year to break even against bonds. Buyers who came in during August on momentum have less reason to stay. The dollar index at a two-month high adds to the pressure on anyone pricing gold outside the US.
Official demand provides the main support. Central banks bought 289 tonnes in the second quarter, up 62% on a year earlier, the World Gold Council reports. Poland added 51 tonnes and China 33 tonnes, its biggest quarterly purchase since late 2023. Nine in ten reserve managers surveyed expect global holdings to keep rising. Those buyers have little interest in Treasury yields; they are diversifying away from dollar assets that can be frozen.
That demand explains the floor rather than the level. Reserve managers buy steadily and tend to buy more on weakness. That is why the physical bid keeps appearing whenever gold dips toward $4,230, as it did on Thursday. It is also why September has been a slide rather than a crash. Central banks did not drive gold up 13% in August, and they are not the reason it is down about 6% this month. The swing money is in ETFs and futures, and that money is rate-sensitive.
Silver is behaving differently, which is the more interesting signal. The gold-silver ratio has fallen to about 67 from around 70 at the start of the month, meaning silver has held its value while gold fell. Silver rose 1.85% to around $65 on Friday morning as the dollar and yields paused, the Financial Mirror reported; OCBC's strategists see oil and rates as the main swing factors for gold. The white metal has an industrial leg that gold lacks, and it already absorbed its speculative wash-out in January. After a 47% drawdown, less leveraged money is left to leave. Physical buyers, including Indian demand ahead of the festive season, are finding value at these levels.
The main risk to this view is a policy reversal. If the bond sell-off became disorderly enough for the Treasury to expand buybacks again, or for the Fed to stop hiking because of market stress, the August trade would come back fast. That is a real possibility with the 30-year yield at its highest since 2004 and US debt past $40 trillion. It would take evidence of market dysfunction. A 10-year at 5.1% is expensive money. So far it still clears.
The near-term calendar is set by the Fed. August PCE inflation data is due today, and the October 28 decision follows. We expect gold to stay below $4,300 into that meeting and to test support around $4,200 if the Fed raises rates again, with central-bank buying stopping the slide well short of $4,000. Silver should hold above $60 and keep narrowing the ratio. Gold's next leg higher will begin when the Fed signals that it is finished tightening. That point has not been reached.