Rate cuts should be good for bonds and dividends. So why is gold shining?

Central-bank rate cuts should be terrific for bonds and dividend-paying stocks. But another asset has been grabbing attention with better performance: gold.
And some observers expect bullion will continue to dominate.
If this comes as a surprise, you’re probably not alone. As U.S. inflation subsided and the Federal Reserve cleared the way this year for cutting its key interest rate from multiyear highs, rate-sensitive assets rallied.
The yield on the 10-year U.S. Treasury bond, easily the most important benchmark for government bonds, was above 5 per cent a year ago. But by the time the Fed cut its key rate by half a percentage point in September, the yield had declined to about 3.6 per cent.
That’s a steep descent, and it offered a source of encouragement for investors stuck with floundering bonds and dividend-paying stocks in their portfolios over the past couple of inflation-fuelled years: As yields fall, bond prices rise.
A few popular exchange-traded funds illustrate the relief that followed the shift in monetary policy.
The iShares Core U.S. Aggregate Bond ETF AGG-A rallied as much as 10 per cent over the past year. Here, the iShares Core Canadian Universe Bond Index ETF XBB-T gained nearly the same amount, as the Bank of Canada took an earlier and more aggressive approach to rate cuts, which began in June and continued through this week.
And the iShares Canadian Select Dividend Index ETF XDV-T, which offers exposure to 31 dividend-paying stocks, soared as much as 30 per cent over the past year.
Clearly, rate cuts are good news. This week, the Bank of Canada slashed its key rate by half a percentage point, marking the fourth straight cut. Economists expect more cuts are coming.
But here’s where the relationship between monetary policy and rate-sensitive assets gets a bit blurry: The rally in bonds and dividend stocks appears to be sputtering.
The yield on the 10-year U.S. Treasury bond sat above 4.2 per cent for much of this week, as bond prices declined. Bond ETFs are now off their recent highs.
Canadian dividend stocks, which may be taking their cues from the bond market, have essentially stalled over the past two weeks and retreated slightly after this week’s rate cut.
Is this just a blip, as the market digests the big moves of the past 12 months?
Maybe not – which could open up other opportunities, including an extension of the gold rally.
The backup in bond yields hasn’t come as a surprise to some observers. Ed Yardeni, a former Wall Street strategist who is now president and chief investment strategist at Yardeni Research, argued in August that strong economic indicators would undermine expectations for aggressive rate-cutting by the Fed.
“The bond market seems to agree with our view that the Fed may be stimulating an economy that doesn’t need it,” Mr. Yardeni said in a note this week.
But if bonds and dividend-paying stocks are now frustrating investors who expected more from a decisive victory over inflation, gold is offering an alternative view of a future where inflation and geopolitical tensions persist.
Make no mistake: Gold is not cheap or unloved. The commodity has been breaking records this year, and touched a new high of US$2,759.80 an ounce this week. That’s up 32 per cent over the past eight months.
The share prices of gold producers have done considerably better, after a slow start to the year. The NYSE Arca Gold BUGS Index, which tracks global producers including Toronto-listed Agnico Eagle Mines Ltd. AEM-T and Kinross Gold Corp. K-T, has risen 64 per cent since the end of February.
The bullish case rests on gold offering a valuable hedge against rising uncertainties over, well, almost everything.
Max Layton, a commodities analyst at Citigroup, reiterated his view this week that gold will rise to US$3,000 an ounce within six months, as investors seek a hedge against a broader market downturn or a spike in oil prices if Middle East conflict escalates.
Hugo Ste-Marie, a strategist at Bank of Nova Scotia, argued in a note that gold will also be a strong bet if the U.S. presidential election results turn messy.
And Mr. Yardeni believes that gold may offer a better refuge than U.S. Treasury bonds, especially when some countries, including China, are boosting their allocation to gold in their international reserves.
Bonds and dividend-paying stocks still look promising. But gold looks hard to beat.