Negative real rates puts shine on Getchell’s gold

Negative real rates puts shine on Getchell’s gold Richard (Rick) Mills, Ahead of the herd via Gold Seek

A number of factors influence gold prices (mainly the US dollar, gold ETF inflows/ outflows, inflation rate, bond yields, safe haven demand, physical gold demand, gold supply) but none is more reliable than real interest rates.

The demand for gold moves inversely to interest rates – the higher the rate of interest, the lower the demand for gold, the lower the rate of interest the higher the demand for gold.

The reason for this is simple, when real interest rates (interest rate minus inflation) are low, at, or below zero, cash and bonds fall out of favor because the real return is lower than inflation – if you’re earning 1.6% on your money from a government bond, but inflation is running 2.7%, the real rate you are earning is negative 1.1% – an investor is actually losing purchasing power. Gold is the most proven investment to offer a return greater than inflation, by its rising price, or at least not a loss of purchasing power.

The gold price is tied to low or negative real interest rates which are essentially the by-product of inflation – central banks drop interest rates when the economy is running too hot, demonstrated by an increase in the consumer price index. In the US, this means inflation greater than 2%.

Bond market and gold market observers keep a close eye on US Treasury yields, particular the yield on the benchmark 10-year note.

When real bond yields are low, the price of gold can and will rise; on the flip side, when real rates are rising, gold can fall very quickly.
There’s a saying that “6% interest can draw gold from the moon,” undoubtedly true, but rates below 2% also draw investors to gold, because that means the real interest rate, if inflation is trending about 2%, is approaching 0%, the point where bond investors lose their purchasing power and start looking around for an investment that will protect it, ie., gold.

Historically we can see the inverse relationship between real interest rates and gold, by comparing two charts, the gold price over the last 20 years, and the yields on 10-year Treasury Inflation-Indexed Securities (TIPS), which analysts use as a proxy for real interest rates, charted over the same period.

Notice that the TIPS blue line dips under the 0% baseline between 2012 and 2014, nearing -1%. Gold represented by the yellow line rises gradually from 2002 then climbs sharply after 2010, reaching its all-time high of $1,917/oz in 2011. In 2015, we see gold falling in anticipation of the US Federal Reserve hiking interest rates, and the resultant rise in the US dollar at the same time as real interest rates, ie. the TIPS blue line, are rising.

In an article titled ‘The Golden Dilemma’, authors Claude Erb and Campbell found a near-perfect negative correlation of -0.82 (-1 being a perfect negative correlation) between real interest rates and gold prices between 1997 and 2012. Going back further in history, when real interest rates turned negative during the second half of the 1970s, gold moved as high as $1,900 an ounce, as real rates  plummeted as low as -6%. When Paul Volcker, Fed Chair under President Carter and Reagan, hiked short-term nominal interest rates, real rates returned to positive, ending gold’s run. In fact the gold price continued to drift downward, reaching a 30-year low under $400 an ounce in 2001. The gold bull market of 2010 to 2013 is easily seen in juxtaposition with negative real interest rates which bottomed out at around -4% during that same period.

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