Treasury Yields, Inflation, Real Yields and Gold – Setting Stops to Filter Out Noise

Bonds and gold were spooked last week as the 20+ Yr Treasury Bond ETF (TLT) fell 4% and the Gold SPDR (GLD) fell 2.81%. Note that GLD surged over 2% on Monday’s open and then fell over 5% the last three days of the week. Wow! Today we will look at the 10-yr Yield, Inflation, the Real Yield and gold. There is an interesting narrative at work, as always, but we are usually better off focusing on the chart of the underlying and ignoring the narrative.  I will also talk about at stop-loss technique with GLD.

The chart below shows the 10-Year Treasury Yield and the 10-year Breakeven Inflation Rate (T10YIE), which comes from the St Louis Fed database (FRED). We can see that the 10-yr yield was clearly higher than the inflation rate from September 2018 to September 2019. After converging for several months, the 10-yr Yield plunged along with the inflation rate and yields were lower than inflation. This means the Real Yield was negative.

The Inflation Rate picked up in the second quarter of 2020 and exceeded its 2019 highs in December and January (blue shading). The 10-yr Yield remained subdued and formed a rounding bottom of sorts from March to October 2020 (green line). A breakout occurred in November and this coincided with a breakdown in Treasury Bonds (TLT, IEF). Bonds loathe inflation because it eats into the returns and sometimes results in negative returns (Real Yield below zero).

The next chart shows the 10-Year Yield less the Inflation Rate, which is the Real Yield. This is the same as the 10-yr Treasury Inflation-Indexed Security Constant Maturity (DFII10) from FRED. The Real Yield was positive for most of 2019 and then turned negative in late January 2020. We can also see that the decline in the Real Yield coincided with a rise in GLD. There is also a loose positive correlation between the two over the last five months.

The next chart shows the Real Yield and GLD since 2009. Notice how GLD surged as the Real Yield fell from 2009 until mid 2011. The Real Yield fell further and turned negative, but GLD stopped rising (red zone). GLD then traded sideways as the Real Yield meandered in positive territory from mid 2013 to mid 2019 (blue shading). Notice that GLD started rising when the Real Yield started falling in early 2019. This brings us to 2021. The Real Yield is seriously negative and GLD is trying to break out of a falling channel.

This correlation with the Real Yield seems like a good narrative for gold, but we need to be careful with narratives because they are subject to change – without notice. The markets are forward-looking beasts designed to discount future events, which we cannot predict. We do not know if the Real Yield will fall to -2 or quickly revert back to positive, as it did in 2013. We can usually find a narrative to justify past price moves (hindsight), but these narratives do not always apply to future price moves. Relationships change.

The Big Picture for GLD

The weekly chart sets up the big picture. GLD surged some 40% and hit a new high in August. The ETF then fell back to the rising 40-week SMA with a 50% retracement that formed a falling channel. A correction after a big advance is normal. Furthermore, the retracement amount and the pattern are typical for corrections within bigger uptrends. GLD broke out in late December and then forged a big outside reversal week in early January. This is not the price action bullion bulls want to see, but it does not negate the big picture just yet.

The Tactical Picture for Gold

On the daily chart, GLD fell back below the breakout zone with a hard decline the last three days. At this point, the chances of a failed breakout are real. However, I would be willing to give gold a little wiggle room because of the big picture. Notice that the three day decline retraced 2/3 of the prior advance (early December to early January) and GLD is right at the rising 200-day. RSI is also in the 40-50 zone, which acts as momentum support in an uptrend. This is the moment of truth for gold. I am willing to chalk up Friday’s price action to noise, but would have to re-evaluate on further weakness below 170.   

As noted in the article on trailing stops, there is a stop-loss technique that I use to filter noise. Sometimes it averts a whipsaw and sometimes it doesn’t. First, I place a mental stop based on a chart level or the ATR Trailing Stop. This stop is based on closing prices. When price closes below the stop, I then place a sell stop just below the low of the last bar. This is not based on the close and can trigger during the trading days. For GLD, this would be just below 170.

You can learn more about ATR Trailing stops in this post, which includes a video and charting option for everyone.

Thanks for tuning in and have a great day!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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