Why the gold price rally may continue

We often write about the different market developments that can impact the returns of gold within investor portfolios. The primary factors that we consider are:

• Policy of the US Federal Reserve (Fed)
• Consumer Price Index (CPI) measures of inflation
• Behaviour of the US Dollar
• Levels of interest rates—particularly the US 10-Year Treasury Note
• Gold futures speculative positioning

While we believe that these are among the most important factors that explain movements in the gold price, we couldn’t say that they are the sole determinants as to why the price moves. Technical factors, such as the ratios of gold to US equities, gold to US government bonds, and gold to the US Dollar are also certainly worth considering. Below, we look at these ratios and explore the implications for the gold price.

Gold technicals: the gold price to US equities ratio

Since the end of 2009, there have been two dominant trends within the relationship between the price of gold and US equities, as shown through the performance of the S&P 500.

• From 31 December 2009 to 22 August 2011, the price of gold appreciated by nearly 40% annualised while the S&P 500 only gained about 1% per year
• From 22 August 2011 to 8 February 2019, the S&P 500 gained about 14% per year, while the price of gold lost nearly 5% per year

At the risk of stating the obvious, US equities have been the star performers at the expense of most other asset classes since 2011, gold included. But we’d note that in Figure 1, which shows the ratio of the gold price to the S&P 500, we see a falling wedge pattern. The performance of US equities was strong enough recently to push the line—designed such that it declines when US equities are outperforming gold—outside the lower boundary of the falling wedge. This move was short-lived, and technicians have noted that when moves like this fail to establish a trend, the reverse move may occur quite quickly. This suggests that gold could potentially outperform US equities in the near term.

Figure 1: The relationship between gold and US equities may be changing

Source: Bloomberg, with period from 31 December 2009 to 8 February 2019. Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Gold technicals: the gold price to long-maturity US government bonds ratio

One of the big debates among investors today is in relation to where US interest rates—particularly long-term US interest rates—may go to from current levels. From the early 1980s to the present, the trend has clearly been down, leading to massive price appreciation for bond investors. Now, however, with interest rates near historic lows, many hypothesise that the next 10 or 20 years could look very different to the last 30 to 40 years.

In Figure 2, we show the ratio of longer-dated US government bond cumulative returns against the price of gold, using the ICE US Treasury 20+ Year Index as a measure of the returns from US government bonds. The chart shows:

• From 2004 to 2011, the price of gold outperformed longer-maturity US government bonds, resulting in an upward trend in the ratio
• From 2011 to about 2014, longer-maturity US government bonds outperformed gold, resulting in a downward trend in the ratio
• From 2014 onwards, we have observed a strong multi-year basing process, and it looks like the price of gold is again starting to outperform long-maturity US government bonds

While this ratio cannot guarantee that the price of gold will outperform longer-maturity US government bonds going forward, we think that the ratio is an interesting way to consider a longer-term historical context and relationship between the two assets.

Figure 2: Gold may be poised to outperform US government bonds

Source: Bloomberg, with period from 31 December 2004 to 8 February 2019. Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Gold technicals: major trends in the relationship between the US Dollar and the gold price

Gold (and many other commodities) is priced in US Dollars, leading to a natural tendency of the price of gold to rise as the value of the US Dollar falls. Figure 3 indicates that since the late 1960s, the US Dollar has had four regimes of significant depreciation. It is clear that the price of gold responded during these periods by moving significantly higher.

On the right-hand side of Figure 3, we indicate that a pattern has developed recently that looks similar to patterns that we have seen in the past prior to a big US Dollar move down and a subsequent upward move in the price of gold. While this pattern is by no means a guarantee of future performance, we do believe that analysing the long-term relationship between the US Dollar and gold is helpful in stepping outside the minute-by-minute, hour-by-hour, and day-by-day short-term analysis that the world has become accustomed to.

Figure 3: The US Dollar versus gold price relationship since the late 1960s

Source: Bloomberg. Periods of the US dollar are defined as Sept. 1969 to June 1973 (Period 1), June 1976 to June 1980 (Period 2), December 1984 to December 1987 (Period 3) and June 2001 to March 2008 (Period 4). Periods of the gold price are December 1969 to December 1974 (Period 1), Sept. 1976 to Sept. 1980 (Period 2), December 1984 to December 1987 (Period 3) and March 2001 to Sept. 2012 (Period 4). Concept for chart from blog post by JC Parets on 6 February 2019. Historical performance is not an indication of future performance and any investments may go down in value. You cannot invest directly in an index.

Conclusion: the price of gold may appreciate further

We have written recently that, based on our forecast and internal models as of 31 December 2018, gold’s price could reach $1,370 per troy ounce by 31 December 2019. This forecast was based primarily on fundamental factors, rather than technical factors. However, analysing the three charts above, we believe that gold’s further appreciation could also be supported from a technical perspective.

This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.

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A Market to Revisit

Emerging Markets Local Currency Bonds: A Market to Revisit

Emerging markets (”EM”) government bonds, particularly those denominated in local currencies, have bounced back in 2016. It’s time to look again at what they can offer. A Market to Revisit.

The past few years have not been kind to EM local currency bonds. Falling commodity prices and concerns about slowing global growth resulted in weak performance across many EM asset classes. Local currency bonds were particularly impacted by the robust U.S. dollar, which remained strong throughout 2015, and the prospect of four potential Federal Open Market Committee rate hikes in 2016. These headwinds caused investors to push valuations down to levels of extreme weakness, particularly on several EM currencies, which may have been oversold heading into 2016.

Q1 Tailwinds Provide Support

However, the Federal Reserve’s sentiment may have changed. The Fed appears to be taking a more dovish stance and the market is now expecting fewer rate hikes this year. Some immediate results could include a pullback in the U.S. dollar and the re-emergence of a risk-on appetite. These tailwinds have been strengthened by the first quarter rebound in commodity prices and the prospect of pro-growth political reform in several EM countries.

EM local currency bonds benefited from these supportive factors, which contributed to a return of 11.02% in the first quarter, as represented by the J.P. Morgan GBI-EM Diversified Index, significantly outperforming EM hard currency sovereign bonds and corporates. Every country in the index had both positive local bond market returns and currency appreciation for the period. Dedicated local currency funds also received significant inflows towards the end of the quarter.

Positive Flows as Investors Take Notice

Why the positive flows? After years of volatility and weak performance, EM local currency bonds may be underrepresented in many investors’ portfolios. In addition to market conditions being favorable in the first quarter, local currency bonds have some particularly attractive characteristics that stem from two distinct sources of return they provide: local interest rates and currencies.

Because of these distinct drivers of return, local currency EM bonds have exhibited low historical correlations with other segments of the fixed income market, especially core U.S. investment grade sectors, as shown below. Local currency EM bonds have also historically provided higher yields versus other EM bond sectors, with an investable universe that tends to be skewed more towards higher quality issuers. For example, 84% of local currency EM government bonds were rated investment grade at the end of the quarter, versus 63% of those denominated in hard currencies, as measured by the BofA Merrill Lynch Emerging Markets External Sovereign Index.

Low Correlation to Certain U.S. Fixed Income Sectors

As of March 31, 2016
(Click to enlarge) Source: Morningstar.

Historically Higher Yields Versus Other EM Sectors

As of March 31, 2016

(Click to enlarge) Source: FactSet. Index performance is not illustrative of fund performance. Fund performance current to the most recent month end is available by visiting vaneck.com/emlc.

These unique drivers of return are also sources of risk, and should be considered along with credit, economic, political and other risks associated with EM investments.

We believe that local currency EM bonds may potentially provide unique diversification benefits within a global fixed income portfolio, with both potentially higher yields and higher credit quality versus other EM fixed income sectors. For investors who have reduced their exposure in recent years, we believe it is a market worth revisiting.

Investors interested in this space may find easy access to local currency denominated bonds issued by emerging markets governments through VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC).

Authored by William Sokol, Product Manager, ETFs

ETFs is authored by VanEck thought leaders. VanEck is the sponsor of VanEck Vectors ETFs and is currently among the largest providers of exchange traded funds (ETFs) in the U.S. and worldwide. VanEck Vectors ETFs empower investors to help build better portfolios with access to compelling investment themes and strategies. Our ETFs span many global asset classes, and are built to be transparent, liquid, and pure-play reflections of target markets.


1 Source: J.P. Morgan Emerging Markets Bond Index Monitor, as of 3/31/16.
2 Correlation measures how two securities move in relation to each other.

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The indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees, or expenses that are associated with an investment in any underlying exchange-traded funds. Historical performance is not indicative of future results; current data may differ from data quoted. Indexes are unmanaged and are not securities in which an investment can be made.

JPMorgan GBI-EM Global Diversified Index (GBI-EM) tracks local currency denominated EM government debt.

BofA Merrill Lynch Emerging Markets External Sovereign Index (EMGB) tracks US dollar and Euro denominated EM government debt.

The asset classes referenced in the charts are represented by the following indices: High Yield Bonds: Barclays US Corporate High Yield Index measures the market of U.S. dollar denominated, non-investment grade, fixed-rate, taxable corporate bonds. Investment Grade Corporate Bonds: Barclays US Corporate Investment Grade Index tracks the investment grade, fixed-rate, taxable, corporate bond market. Inflation Linked Bonds: Barclays US Government Inflation Linked Index tracks US Treasury Inflation Protected Securities (TIPS) with at least one year until final maturity Broad US Investment Grade: Barclays US Aggregate Bond Index tracks the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS, ABS and CMBS. Treasuries: Barclays US Treasury Index tracks U.S. dollar-denominated, fixed-rate debt with at least one year until final maturity issued by the U.S. Treasury. EM Local Sovereigns: JPMorgan GBI-EM Global Diversified Index (GBI-EM) tracks local currency denominated EM government debt. EM USD & EUR Sovereigns: BofA Merrill Lynch Emerging Markets External Sovereign Index (EMGB) tracks US dollar and Euro denominated EM government debt. EM USD Corporates: BofA Merrill Lynch US Emerging Markets Liquid Corporate Plus Index (EMCL) tracks the US dollar denominated nongovernment debt of EM.

Diversification does not assure a profit nor protect against loss.

An investment in the Fund may be subject to risk which include, among others, credit risk, call risk, interest rate risk, and sovereign defaults, all of which may adversely affect the Fund. High yield bonds may be subject to greater risk of loss of income and principal and are likely to be more sensitive to adverse economic changes than higher rated securities. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact the Fund’s return. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability. The Fund’s assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.

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