The Inversion Effect

In a bullish sign for gold, the yield on the two-year U.S. Treasury note topped the ten-year Treasury yield in late March for the first time since 2019. Such an “inversion” in the Treasury yield curve, history has shown, is a good indicator of an impending recession, which could send investors fleeing to the safety of gold as stock prices fall.

Inversion of the 2-year/10-year Treasury yield curve. Source: Federal Reserve Bank of St. Louis

Normally, long-term yields are significantly higher than short-term yields as investors demand a higher return for lending their funds to borrowers for a longer period of time. But the yield curve has been flattening for months, as short-term interest rates have been climbing at a far higher pace than long-term interest rates.

While an inversion often does precede a recession the timing is not precise. Often, a recession may not occur until 12-18 months later.

Still, an environment of a flattening yield curve tends to be positive for gold. When the ten-year Treasury yield flattens relative to the three-month Treasury yield, gold has historically delivered an annualized return of five percent, according to a World Gold Council analysis of prices between 1969 and 2022. That compares to an annualized return of three percent when ten-year Treasury yields were steepening relative to the three-month yield.

Rising interest rates can be an impediment to a higher gold price because gold offers no yield. But currently, real interest rates (interest rates minus the inflation rate) are historically low, reducing the attractiveness of fixed income investments relative to gold.