Gold Price Analysis: XAU/USD rallies back towards weekly highs at $1820 as real yields fall/inflation breakevens rise

• Spot gold has been pressing higher in recent trade and look to be on course to test Tuesday’s $1820 highs.
• XAU/USD has been taking its cue on Thursday from falling real yields and rising inflation expectations.
• Traders and analysts have been warning against reading too much into any market moves this week given year-end illiquidity.

Spot gold prices (XAU/USD) have been pressing higher in recent trade and look to be on course to test Tuesday’s $1820 highs. At current levels close just above $1815, spot gold is on course to close out the session about $13 or roughly 0.7% higher. A strong weekly US jobless claims report, that showed initial claims dropping back under 200K (below pre-pandemic levels) and continued claims falling to just above 1.7M (in line with pre-pandemic levels) does not seem to have weighed on the precious metal.

Typically, strong labour market data would weigh on gold as it would be interpreted as having hawkish implications for Fed policy. But the Fed has gone to great lengths in recent weeks, including at its latest meeting, to acknowledge the tightness of the current US labour market, so Thursday’s data does little to surprise the bank or change this narrative. Instead, spot gold has been taking its cue on Thursday from falling real yields and rising inflation expectations.

The 5-year TIPS yields dropped under -1.63% in recent trade, its lowest level since 9 December and is down nearly 10bps on the day. That has not been accompanied by a fall in the nominal 5-year yield of equal magnitude, thus pushing 5-year break-even inflation expectations higher. 5-year breakevens moved above 2.90% on Thursday and look on course to test the early December highs at 2.92%. Remember that lower real yields is a positive for non-yielding gold as its lowers the “opportunity cost” of holding the precious metal, while higher inflation expectations increase the demand for inflation protection, which gold is seen as offering.

It's not clear why the demand for inflation protection in the form of TIPS has surged this week (hence pushing real yields lower). Traders and analysts have been warning against reading too much into any market moves this week, which are said to be exacerbated by low liquidity/volumes given many market participants are away for year-end holidays. Volumes and conviction are set to return next week and at the start of the new year, with plenty of US data to also give markets some direction/provide talking points.