Bonds vs Gold – 5 Factors affecting Gold Price and their Current Potential

Key takeaways

Bonds vs Gold: Given current market environment with limited Inflation Risk and FED support for Corporate Bonds:

  • Core Bond ETFs or Investment Grade ETFs provide value compared to Gold
  • However,  Gold has an advantage over Treasuries given possible downside with rising rates and negative real returns for Treasuries

Bonds vs Gold

While most risk assets buckled under the strain of the Coronavirus, Gold continued to shine brightly as the haven of last resort. How long can it last? Here below is what you need to know about current relative potential for Gold.

If you owned Gold as portfolio diversifier what are the signs that you need to rebalance into other asset classes e.g. Fixed Income? For simplicity the analysis focuses on whether now is a good time to buy gold assuming investing in the commodity itself rather than Gold Mining Stocks (which are more volatile and less useful as a Hedge for Equities). 

lqd review bond etf performance comparison LQD VCIT VCSH VCLT TLT Gold S&P 500- coronavirus market - covid19 crash
Bonds vs. Gold. Comparison of Coronavirus Sell off for Corporate Bond ETFs, Gold and Long Term Treasuries.
  • Treasuries – Looking from a portfolio protection perspective Long Term Treasury Bonds (iShares 20+ Year Treasury Bond ETF or TLT) were the only asset class with negative correlation that provided best protection during Coronavirus Sell-off. However, Treasuries have currently significant downside risk 
  • Gold has lost ground for technical reasons (although arguably Treasuries had also their share of technical issues) but quickly recovered. It has been a great tool for hedging downside risk. However, current outlook is mixed (see below)
  • Bond ETFs have reacted based on their Risk Profile / Term with longest one (VCLT) very closely correlated with the S&P 500. While they may not have provided great downside risk Corporate Bonds are now supported by the FED (read our review of the main funds here) – you may currently consider Investment Grade Bonds or Core Bond Funds for Income if you feel the below analysis of Gold provides limited upside

Factors Affecting Gold Price

Current Potential based on key factors

#1 Low Real Interest Rates
#2 Weaker USD / Debasement
#3 Further Economic Shocks
#4 High Inflation (Above 3%)
#5 Retail & CB Purchases

#1 Low Real Interest Rates

Bonds vs Gold: Both react the same way, but Bonds provide Income

Current Gold Appreciation Potential from Yields: LOW

of Gold price moves can be explained by Real Yields – the strongest factor, by far

This is the elephant in the room. Investors are turning to gold because of one simple fact – deeply negative Real Yields (Bond Yields after accounting for Inflation). Some of other traditionally safe haven assets like Treasury Bonds are generating negative real returns. The lower they are, the more attractive Gold becomes. After all, buying a bond that is guaranteed to lose you money is a tough sell

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bonds vs gold: real rates gold relationship schroders
Is now a good time to buy Gold? Gold prices have moved in line with real yields which means Bonds vs Gold is a yield opportunity cost problem

Read more on our outlook for Treasury Bond ETFs post the Coronavirus shock. You may also have a look at our Fixed Income Dashboard for current Bond ETF yields. According to BlackRock, Real Yields drive around 30% of the price of Gold – the strongest factor, by far. But not in all environments.

Schroders Strategists analysed Gold performance during three periods: 1982-1999 (High Real Yield), 2000-2008 (Decreasing Real Yields) and 2009-2019 (Low Real Yield). In the first two periods when Bonds offered positive / high real returns there is little relationship between Gold and Real Yields (it may be the case again if Real Rates go up one day).

That said, in current low yield environment there is clearly a strong correlation between rates and Gold prices. You can easily track daily Real Rates from US Department of Treasury website. But, to avoid opening Excel, Schroders plotted the graph for you (see above)

Watch Real Yields closely

Based on a BlackRock analysis it is estimated that during these periods (which we are currently in) the rough rule of thumb is Every 0.10% drop in Real Yields coincides with about a 1.25% increase in Gold Prices. Real Rates are already low. The risk of holding Gold may be the limited future appreciation should negative rates not materialise. However, Treasuries already generate negative real rates and short term instruments may soon follow:

Is the increase in Gold price for every 0.10% drop in Real Yields
Is now a good time to buy vs bonds - jeffrey gundlach t bills negative rates fed funds chair powell
Around the time of that tweet, Gold gained 2% at one point on the back of these discussions.

#2 Little downside from Stronger USD but Debased Dollar may provide boost

Bonds vs Gold: Gold provides protection while Bonds suffer from weaker USD

Current Gold Appreciation Potential from weaker USD: HIGH

Since Gold is quoted in USD you need to follow the Dollar Index (DXY) closely.  Essentially, this tracks how strong is the USD versus a basket of other currencies.  A stronger Dollar vis-a-vis other currencies may mechanically weaken Gold (perceived as the ultimate currency). Historically Gold outperformance is strongest when the Dollar is down. However, during Coronavirus both the Dollar and Gold are perceived as Safe Havens and a stronger Dollar doesn’t have a major impact on Gold. This may change as the Economy stabilises.

More importantly, Monetary Inflation increases prices of all assets including Stocks (read about the disconnect between fundamentals and valuations) and Gold on the back of unprecedented stimulus by the FED. 

Bonds vs Gold Is now a good time to buy Gold paul singer thinks so
Is now a good time to buy Gold? Some of the world’s largest hedge funds are raising their bets on gold, forecasting that central banks’ unprecedented responses to the coronavirus cris

#3 Macro Economic Shocks and Trade Wars

Bonds vs Gold: Protection is somewhat different as Gold reacts more to international tensions, elections and coronavirus. Bonds react the strongest to growth prospects

Gold Appreciation Potential from Additional Shocks: MEDIUM to HIGH

As you can observe, each Jobless claim on Thursday comes with a surge in Gold Prices. Other Economic indicators have similar effect. Gold may ultimately react negatively to a more positive outlook. Any potential geopolitical or Economic Conflict (e.g. Escalation of Trade War with China) may also impact Gold and provide a hedge to your Equity portfolio

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There is also a possibility of other Tail Risks combined with current situation (remember how the Oil Price War escalated quickly). We just don’t know but Gold is an Insurance in these instances. Again, we emphasize that holding Gold is potentially interesting as a diversification tool. Not necessarily as a standalone Asset Class. We took a look on how a hypothetical Portfolio would behave over the past 30 years assuming a mix of Equities and Gold for a 5 Year Holding period – read out takeaways

#4 Inflation Expectations

Bonds vs Gold: Gold provides inflation protection

Current Appreciation Potential from Inflation: LOW

Given the limited upside from lower Real Yields, already priced in low growth outlook the ultimate appeal of Gold would be in a high inflation regime. Now, this one is very binary. There is a large debate whether after a period of deflation we may see some return of high consumer prices. It is clear that in the short term that won’t be the case:

now is the good time to invest in gold - netflix deflation demand elasticity demand subscriptions quantitative easing twitter
This reasoning shows how elastic some stay at home services have become

However, once lockdowns are eased this remains a possibility. According to JP Morgan Gold has provided positive returns during periods of negative growth shocks as well as positive inflation shocks. However, in terms of inflation regimes, average Gold returns have generally been most significant during extremely low (less than 1%) or high (greater than 3%) inflation. Is it a good time to buy Gold with inflation between 1% an 3%? In those episodes gold returns were lackluster. 

In essence, we would need to see a significant jump in inflation for Gold to benefit materially and this is very speculative at the moment given lack of demand. This has also not been the case post the GFC – when gold has been frustrating to trade. The prediction that drove the post-crisis rally — that quantitative easing would lead to high inflation — did not play out. Gold tumbled to below $1,100 by late 2015. Bears can also point to the two-decade slump that followed a high in 1980.


#5 Retail and Central Bank Demand

Gold Appreciation Potential from Retail: LOW to MEDIUM

the relevance of gold as strategic asset class world gold council demand official sector retail bars ETFs central banks
Source: World Gold Council

Demand for Jewellery may probably the weakest aspect of current Gold appeal. Some demand is clearly  dampened in the Short Term. It remains to be seen the degree to which the retail market comes back. This aspect is largerly driven by Emerging Countries and more specifically Asia (50% of overall Gold demand comes from China and India)

Despite initial signalling Emerging Countries’ Banks e.g. Russia may start buying back Gold. It is likely that the long term trend for central banks to be net buyers of Gold post GFC will continue.



Research the appropriate ETFs based on your needs

  • If you decide to invest in Gold you may consider physical gold or Gold ETF
  • Consider combining Gold with Equities (Read how Gold provides diversifiation)
  • We have done some research for you and the Largest Funds are listed below
  • An investment in gold is easily done with listed products, like ETFs or ETCs (How are they different?) These investment products track the spot gold price closely, after taking management fees into account
  • Performance vary by currency (Gold is quoted in USD and then converged into local Fund Currency)
  • We have not included leveraged Funds (understand their risks)
  • As of the date writing of the below table Gold (XAU) price was up 12.22% Year to Date (in USD). So far, SPDR Funds most closely tracked this performance in 2020.
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Large ETF Funds by Fund Size

Data from Bloomberg as of May 9th 2020

Read More about those Funds (Tabs by Exchange)

Investigate Liquidity, Fees, Commissions and Taxes

  • Check the size of the fund and liquidity – it is usually preferable to stick to the larger vehicles that are more liquid (why liquidity matters)
  • Low fees are the most cost-effective feature of an ETF – make sure you select a low fee vehicle. Check the expense ratios from our dashboard or the ETFdb website and plug them here. You can compare the effect of fees on your overall returns using our ETF fee calculator. You may be surprised of the high impact
  • How is the purchase or sale of an ETF going to affect your tax return? While U.S. based ETFs have many tax advantages, a foreign ETF may not be so tax-friendly and therefore not cost-effective. Tax implications vary from region to region
  • Verify any commissions and fees charged by your broker

DISCLAIMER – the views expressed here are my own personal views. The information provided is general in nature only. It does not constitute personal financial advice. You should consider the appropriateness of the information. You should have regard to your objectives, financial situation and needs, and seek professional advice where appropriate. This website is not affiliated with any investment firms. These are meant to be illustrative investments. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. There can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this  newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. 

About Banker on Wheels 27 Articles
Ex Portfolio Manager and Institutional Advisor that witnessed first hand the 2008 GFC and the 2011 European Debt Crisis working for the most prestigious names in the financial industry. Currently on a bike around the world trip in a touring / backpacking mode and cycled close to 15,000 kms over the past year.
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