The old joke is that the stock market has predicted 9 out of the last 5 recessions. However, the yield curve have much better accuracy, as nine inversions of the yield curve since 1953 predicted eight recessions and one credit crunch followed by economic slowdown.
But what is the yield curve? It is a curve, which shows yields for similar bonds but with different maturities. It is a useful economic indicator, which shows the relation between different interest rates. Normally, bond yields rise as maturity gets longer due to the risks associated with time, meaning that the slope of the yield curve is positive.
The most important yield curve is the Treasury yield curve, which usually compares the three-month, two-year, five-year and 30-year U.S. Treasury debt, which create the term structure of (risk-free) interest rates. The slope of the Treasury yield curve may change over time. We say that the yield curve becomes steeper if the longer term interest rates increase relatively to the shorter term interest rates, and becomes flatter if the longer term interest rates decrease relative to the shorter term interest rates. And the yield curve becomes inverted when the longer term interest rates move below the shorter term interest rates. Such changes may be important for the gold market.
Yield Curve and Gold
Let’s look at the chart below, which shows the price of gold and the Treasury yield curve, represented by the spread between 10-year and 2-year Treasury bonds.
Although sometimes a steepening (or flattening) yield curve was accompanied with rising (or declining) gold prices, there were also periods of negative correlation, or when gold moved independently of the changes in the slope of Treasury yield curve (1980s and 1990s). Therefore, there is no clear relationship between the Treasury yield curve and the price of gold.
Inverted Yield Curve and Gold
However, the yield curve can still give us valuable insights into the future of the gold market. Why? Inversion of the yield curve (i.e. a situation when long-term yields fall below short-term ones and the spread becomes negative) is considered to be quite a good predictor of recession. The logic behind this is as follows: credit crunch makes entrepreneurs scramble for resources to complete investment projects, bidding up short term interest rates, while long-term creditors on the other hand accept lower yields, because they expect a slowdown in the future.
Historically speaking, the yield curve inverted about one year before the last three recessions (or actually four if we count the coronavirus recession), including the dot-com bubble and the Great Recession. Therefore, the inversion of the yield curve may be a bullish signal for gold.
However, gold investors should not rely on just one indicator, but should include all fundamental factors influencing the price of the yellow metal and the general context in their analysis. You see, the inversion of the yield curve used to be a relatively good indicator of the recession, but the past great predictive results do not guarantee similar accuracy in the future, especially in times of the central bank’s unconventional monetary policy. The reason is that, because of the quantitative easing and other nonstandard measures, the yield curve is much flatter than it normally would be. So, even if the yield curve inverts, it does not necessarily signal the upcoming recession.