Gold ETFs Can Can Still Regain Their Luster

Investors betting that gold and exchange traded funds such as the iShares Gold Trust IAU would rally in the wake of Republican Donald Trump's shocking victory in Tuesday's presidential election have been disappointed.

Although it has been just two trading sessions since Tuesday, IAU and rival gold ETFs have struggled. This is happening despite the fact it appears unlikely the Federal Reserve will move forward with a December interest rate hike as previously expected. Gold benefits from lower interest rates because, as an asset with no yield, the yellow metal loses allure as bond yields climb.

Volatile Metal

Much of this year's gold volatility can be attributed to investors' knee-jerk reactions to Federal Reserve commentary on interest rates. For example, IAU and rival gold ETFs tumbled last Friday after one Fed member said the central bank should not wait too long before raising rates.

Gold is more attractive when interest rates because there is no yield as there is on a bond fund, meaning capital appreciation is the only way investors in these products are compensated for taking on gold market risk. With the dollar weak and trillions of dollars (and rising) worth of negative-yielding sovereign debt throughout the developed world, a perfect storm for gold has been brewing this year.

Bull Case Not Dead

A Trump victory was supposed to add to gold's ebullience, but that hasn't been the case. Not yet at least, but that doesn't mean the bull case for bullion is dead. Rising inflation could be another boon for gold and inflows to Treasury Inflation Protection Securities (TIPS) and related ETFs suggest investors are concerned about inflation.

“Based on the 10-year Treasury Inflation Protected Securities (TIPS) market, inflation expectations recently hit 1.75%, the highest level since the summer of 2015. To the extent that rates are being driven by changing perceptions of inflation and not real rates, higher interest rates may not be an impediment for gold,” according to a recent BlackRock note.

Accounting for inflation, real U.S. interest are in negative territory, further increasing the potential for out-performance by gold relative to other safe-haven assets.

“Can inflation expectations continue to rise? Probably. Despite the sharp rise in inflation expectations, 10-year breakevens (the difference between the yield on a nominal fixed-rate bond and the real yield on TIPS) remain depressed relative to their long-term history. As recently as two years ago, inflation expectations were roughly 2.25%,” adds BlackRock.

Disclosure: The author owns shares of IAU.