Market Update: July 2020

August 06, 2020

Things Are Looking Shiny

Congress is currently working towards a new stimulus package with the goal of increasing the size of millions of Americans’ unemployment paychecks, but in the interim, the extra $600 that has helped keep consumer spending and income afloat through the previous few months has now expired.

Both sides are trying to reconcile differences between the $3.5 trillion Democratic plan proposed in May and the $1 trillion package that Senate Republicans released recently. Republicans have argued the payments should be reduced due to the generous size of the weekly payment and disincentive to return to work.

With high frequency indicators pointing to a stall in the continued rebound of the economy (travel, dining, credit/debit spending), the Federal Reserve left interest rates near zero and vowed to use all of the tools at their disposal to support a recovery.

Most of the tools the Federal Reserve uses such as cutting interest rates or buying Treasury bonds is to get banks to lend more so businesses can get kick started and invest in projects and people. Interest rates have already been near rock bottom, and the balance sheet of the Fed has swelled by the trillions. This is precisely why Fed Chairman Jerome Powell reiterated the importance of additional stimulus in the form of fiscal measures in his latest speech.

The other big story during July has been the rise of gold. Beginning the year at $1,517 an ounce, it has now broken its previous high back in 2011 and risen to over $2,000 an ounce.  Demand for gold tends to move inversely with interest rates—the lower the rate of interest, the higher demand for gold, the higher the rate of interest the lower demand for gold.

Fear and uncertainty surrounding the coronavirus is driving a dramatic bond rally across the world, which has caused yields to fall precipitously (bond prices and yields move in opposite directions).

Currently, real yields are negative, which has been positive for gold recently and could continue should real rates stay negative. The current 10-year Treasury yield as of the end of July was 0.53%. If you subtract the rate of inflation of 1.56% from the nominal Treasury yield of 0.53%, you get a real rate of -1.03%.1

An illustration of the inverse relationship of gold and real rates is shown below.

Data as of July 31, 2020

A number of other factors can influence the price of gold (US dollar, gold ETF inflows/outflows, physical demand and supply, economic shock, bond yields) but the most reliable is real interest rates.

An investor purchasing a Treasury bond today will experience a loss of purchasing power should inflation stay the same or go higher, meaning the investor would not earn a rate high enough to offset the effects of inflation. This loss of purchasing power is why a shift into precious metals has occurred, and in particular gold. Gold has historically proven to be an investment to offer a return greater than inflation, by its rising price, or at least not a loss of purchasing power.

The S&P 500 has inched higher and is on the cusp of regaining its all-time high. All eyes will be on future stimulus as millions of Americans are still unemployed and struggling. Should lawmakers fail to produce a result soon, uncertainty could creep back in. No one likes uncertainty—the market especially.

1 Source: Bloomberg; 10-year constant maturity rate. 


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