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TIPS Divergence Is A Bad Sign For Gold

Chart In Focus
January 05, 2023

Gold prices are breaking out here in January 2023 after chopping sideways for all of December 2022.  That is getting precious metals investors excited.  But there is a problem with this strength by gold: it is not being confirmed by one of gold’s fellow travelers.

TIP is the iShares ETF which owns various maturities of Treasury Inflation Protected Securities (TIPS).  These are special U.S. Treasury Bonds, issued by the Department of Treasury with terms of 5, 10, or 30 years.  What makes them special is that the principal can increase based on how much inflation there is.  The interest rate paid on the bonds remains the same throughout the life of the bond, but at maturity you can have the principle payout go up if the inflation rate has been positive.  If inflation is negative, that does not harm the principal payout. 

The value of any bond is dependent upon its principal amount, and on how much interest it pays out.  So the curious point about TIPS bonds is that while their principal amount may appreciate with inflation, that inflation also means that 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.

So if you are a buyer of TIPS bonds, what you want to see is lots of inflation, but no general rise in interest rates among other bonds.  That is not usually how life works, though. 

The neat thing about these bonds, and about the TIP ETF is that it is well correlated to gold prices, or at least that is the case most of the time.  Occasionally the two plots disagree, and when they do that usually conveys useful information about what gold is going to do.  Right now, we are seeing a bearish divergence, wherein the price of TIP has been trending downward in December 2022 while gold prices were trending upward.  In the past when we have seen such divergences, that has eventually meant that gold prices have to fall extra hard to get back in sync with what TIP’s price has been doing.

It would be really fun for gold investors if gold prices were going to start another great 1970s style bull market.  Maybe they will, someday.  But right now, this bearish divergence between gold prices and the share price of TIP says that now is not the moment for that great uptrend to commence.

Tom McClellan
Editor, The McClellan Market Report

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