Gold in a market that fears the dollar

Gold as the winner of the USD sell-off

Gold has emerged as one of the key beneficiaries of the recent dollar sell-off. The trigger was the US Treasury’s attempt to curb the rise in long-dated Treasury yields, and it used more than one tool to do it.

The first was an FX intervention in support of the Japanese yen. Beyond stabilising the currency, the move was meant to keep Japanese policy rates low and keep Japanese investors invested in US Treasuries – one of the largest foreign holders of US paper.

The second was a pair of signals that the Treasury itself would step in to buy long-dated bonds, funded either by the proceeds from sales of short-dated paper (an ‘Operation Treasury Twist’) or directly from its account at the Fed, the Treasury General Account (TGA).

Why this helps gold

Each of these steps worsens the risk-reward trade-off for Treasury investors at a time when US debt levels are already rising. That alone burnishes gold’s appeal as a safe-haven asset.

But the more important channel is monetary. The policy announcements threaten to flood the market with dollar cash, they have fanned US inflation fears and they have pushed US real yields lower. Lower real yields are the single strongest driver of gold, and the debasement narrative gives the metal an additional bid as a currency hedge.

There is a possible second act. If the FOMC decides to lower the average duration of its bond holdings as part of its balance sheet overhaul, a ‘Fed Operation Twist’ would flatten the Treasury curve further. A flatter curve makes short-USD hedges cheaper to run and more profitable, which is another blow to the dollar against gold.

The weaponised dollar and the de-dollarisation bid

Gold should also benefit from market fears that the Trump administration will keep using the dollar as a policy weapon. The newest round of US economic sanctions against Iran and the latest trade tensions between the US and Canada have both revived those concerns.

We have already seen the response in official sector flows. Several emerging-market central banks have increased their gold purchases – including central banks of energy importers that sold gold reserves aggressively in search of dollar liquidity at the start of the Iran war. Those reserves are now being rebuilt.

If that pattern holds, the de-dollarisation theme could stage a return as a structural support for gold, on top of the cyclical tailwind from lower real yields.

Bottom line

The Treasury’s yield-cap measures, the risk of a Fed twist and the weaponised-dollar narrative all point in the same direction: a weaker dollar and lower real yields. That is the combination in which gold historically performs best, and it is the reason we keep a constructive bias on XAU/USD even after the sharp August rally.