Commodities Corner: Here’s what TIPS bonds indicate about the outlook for gold

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Gold prices rallied at the start of 2023, but Tom McClellan, editor of The McClellan Market Report, offered a reason why those gains may not be the breakout for prices that investors are hoping for.

Gold futures on Wednesday logged a fourth-straight session gain, with prices for the most-active contract GC00, -0.92%   GCG23, -0.92% settling at $1,859 an ounce on Comex, the highest since June 10, according to FactSet data.

Read: Why gold prices may be headed for record highs this year

Prices for the metal had been “chopping sideways for all of December 2022,” and the recent price rise is “getting precious metals investors excited,” said McClellan, in a note to clients on Thursday.

However, the strength by gold is “not being confirmed by one of gold’s fellow travelers,” he said, pointing to a divergence between near-term gold futures and the performance of the iShares TIPS Bond exchange-traded fund TIP, -0.00%.

Near-month gold futures vs. the iShares TIPS Bond ETF

Tom McClellan/The McClellan Market Report

The TIP ETF owns various maturities of Treasury Inflation Protected Securities (TIPS), whose principal value can increase based on how much inflation there is. The interest rate paid on the bonds remains the same through the life of the bond but at maturity, the principal payout goes up if the inflation rate has been positive, McClellan explained. If inflation is negative, that “does not harm” the principal payout.

He points out that while the principal amount for TIPS bonds may appreciate with inflation, that inflation also means interest rates generally are likely to rise. “So the value of the fixed interest rate payouts gets harmed, reducing the value of the bond, even though the eventual maturity value goes up because of inflation,” he said.

Ideally, buyers of TIPS bonds want to see lots of inflation but no general rise in interest rates among other bonds, but that’s “not usually how life works,” said McClellan.

Still, these TIPS bonds — and the TIP ETF — are usually well correlated to gold prices, he said, and right now, there is a bearish divergence.

The price of the iShares TIP Bond ETF has been trending downward in December 2022, while gold prices were trending upward, said McClellan. Such divergences in the past have seen gold prices falling “extra hard to get back in sync with what TIPS’s price has been doing,” he said.

So while it would be “really fun for gold investors if gold prices were going to start another great 1970s style bull market,” the bearish divergence between gold prices and the share price of TIP “says that now is not the moment for that great uptrend to commence,” said McClellan.

This article was originally published by Marketwatch.com. Read the original article here.

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