Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Stock Market Final Thrust Review - 19th Jan 20
Gold Trade Usage & Price Effect - 19th Jan 20
Stock Market Trend Forecast 2020 - Trend Analysis - Video - 19th Jan 20
Stock Trade-of-the-Week: Dorchester Minerals (DMLP) - 19th Jan 20
INTEL (INTC) Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 18th Jan 20
Gold Stocks Wavering - 18th Jan 20
Best Amazon iPhone Case Fits 6s, 7, 8 by Toovren Review - 18th Jan 20
1. GOOGLE (Alphabet) - Primary AI Tech Stock For Investing 2020 - 17th Jan 20
ERY Energy Bear Continues Basing Setup – Breakout Expected Near January 24th - 17th Jan 20
What Expiring Stock and Commodity Market Bubbles Look Like - 17th Jan 20
Platinum Breaks $1000 On Big Rally - What's Next Forecast - 17th Jan 20
Precious Metals Set to Keep Powering Ahead - 17th Jan 20
Stock Market and the US Presidential Election Cycle  - 16th Jan 20
Shifting Undercurrents In The US Stock Market - 16th Jan 20
America 2020 – YEAR OF LIVING DANGEROUSLY (PART TWO) - 16th Jan 20
Yes, China Is a Currency Manipulator – And the U.S. Banking System Is a Metals Manipulator - 16th Jan 20
MICROSOFT Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 15th Jan 20
Silver Traders Big Trend Analysis – Part II - 15th Jan 20
Silver Short-Term Pullback Before Acceleration Higher - 15th Jan 20
Gold Overall Outlook Is 'Strongly Bullish' - 15th Jan 20
AMD is Killing Intel - Best CPU's For 2020! Ryzen 3900x, 3950x, 3960x Budget, to High End Systems - 15th Jan 20
The Importance Of Keeping Invoices Up To Date - 15th Jan 20
Stock Market Elliott Wave Analysis 2020 - 14th Jan 20
Walmart Has Made a Genius Move to Beat Amazon - 14th Jan 20
Deep State 2020 – A Year Of Living Dangerously! - 14th Jan 20
The End of College Is Near - 14th Jan 20
AI Stocks Investing 2020 to Profit from the Machine Intelligence Mega-trend - Video - 14th Jan 20
Stock Market Final Thrust - 14th Jan 20
British Pound GBP Trend Forecast Review - 13th Jan 20
Trumpism Stock Market and the crisis in American social equality - 13th Jan 20
Silver Investors Big Trend Analysis for – Part I - 13th Jan 20
Craig Hemke Gold & Silver 2020 Prediction, Slams Biased Gold Naysayers - 13th Jan 20
AMAZON Stock Investing in AI Machine Intelligence Mega-trend 2020 and Beyond - 11th Jan 20
Gold Price Reacting to Global Flash Points - 11th Jan 20
Land Rover Discovery Sport 2020 - What You Need to Know Before Buying - 11th Jan 20
Gold Buying Precarious - 11th Jan 20
The Crazy Stock Market Train to Bull Eternity - 11th Jan 20

Market Oracle FREE Newsletter

Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Real Interest Rates, The Key To Reading The Gold Bull

Commodities / Gold and Silver 2012 Apr 09, 2012 - 03:38 PM GMT

By: Submissions

Commodities

Best Financial Markets Analysis ArticleMark Motive writes: After peaking at $1,780 in late February, gold dropped over $100 in March, finishing the month at $1,662.50.

Whenever there is a big move up or down, we all naturally seek confirmation and reassurance of our investment strategy, which is why investors must use objective measures to evaluate and re-evaluate their positions.


As someone who is invested in gold bullion, I enjoy speaking with like-minded people. Many agree that the United States' massive budget deficits and global monetary inflation support the gold bull market. I don't see this changing in the near future. Still, sentiment is not enough upon which to rely - I need a yardstick.

For me, that yardstick is US real interest rates. Real interest rates represent the inflation-adjusted interest rate on 'risk-free' assets, such as US Treasuries. In other words, if a Treasury bond is held to maturity, the real interest rate shows if the bond investor is losing money due to inflation even if the bond posts a profit.

Calculating Real Interest Rates

There are many variations of this measure, but I use 1-year, constant-maturity US Treasury Bill yields as my starting rate and 1-year US food inflation as the adjustment factor.

Using food as a proxy for inflation is insightful for a few reasons: 1) it's a good that everyone buys, so it has an impact on most everybody, 2) agricultural commodity price increases are quickly incorporated into consumer food prices, so it's quick to mirror real world inflation, and 3) the food industry is well-developed, so food prices already incorporate savings gained by large-scale production.

By no means is my methodology the only way to calculate real interest rates. Some investors choose to use longer-dated Treasuries and various other measures of inflation, such as the Consumer Price Index (CPI). However, I don't use the CPI because I believe it has been heavily manipulated over the years and may not be a fair representation of inflation. For example, the goods and weightings used to calculate CPI have been revised over time based on changing quality and the availability of substitutes. This means that CPI is more of a cost of living measure than a pure price measure.

That said, regardless of the methodology used, most calculations of real interest rates will vary only in magnitude, not direction.

Why Use Real Interest Rates?

Let's look at 2011 to illustrate how negative real interest rates affect investors. A 1-year US Treasury Bill purchased on the first trading day of 2011 would have earned about 0.29% if held until maturity. Meanwhile, during 2011, US food prices rose a whopping 4.4%. Using my methodology, someone who placed his savings in a 1-year US Treasury Bill at the beginning of 2011 would have lost 4.11% in purchasing power over the course of the year, despite investing in "safe" US government bonds. This is very bullish for gold.

Negative real interest rates are a direct result of the Federal Reserve's official policy to maintain favorable government borrowing costs: print money to buy Treasuries at artificially low yields and create inflation to allow the Treasury to pay back the debt in cheaper dollars. This is default by stealth and a direct transfer of wealth from savers to borrowers. The common term for this phenomenon is 'financial repression'.

The chart below shows the US real interest rate over the past 60 years. The shaded areas are periods in which gold experienced a bull market. As you can see, these periods occurred when real interest rates were low or negative and highly volatile. By contrast, the gold bear market of the 1980s and 1990s occurred when real interest rates were higher, positive, and relatively steady. (Prior to the late 1960s, the gold price was still heavily influenced by the Bretton Woods system and gold prices were fairly flat.)

Source: Plan B Economics

While this does not prove the causality of the relationship, it makes sense intuitively. Gold performs well during periods of negative real interest rates because there are fewer alternatives for investors seeking to preserve capital and purchasing power. If a US Treasury bond provides a negative after-inflation yield, can it still be considered a safe haven? Most sophisticated investors would answer "no," because it's a money-loser right out of the gate (and has a lot of downside risk if nominal yields rise).

Additionally, real interest rate volatility implies that investors are uncertain about Treasury prices and future inflation. This could be caused by financial conditions that are strained beyond the realm of the normal business cycle, such as an unresolved global banking crisis or unsustainable debt. We're facing both of these crises today.

The Big Picture

Even during periods of negative real interest rates, there are times when US Treasuries perform well in comparison to hard assets - usually during short-term periods of financial stress when investors are scrambling. However, under normal conditions, a US Treasury bond can be expected to provide a total return that is close to its coupon rate, which today is below the rate of inflation.

Any investor using real interest rates to gauge the gold bull market must look through short-term fluctuations to see the secular trend. And today - while the US is overloaded with debt and the Federal Reserve is printing money without hesitation - the secular trend of negative real interest rates remains intact.

What does this mean for the current gold bull market? One day, the gold bull market will end, but given the current outlook for continued negative and volatile real interest rates, but the evidence suggests that day is well in the future.

Mark Motiveis the pen name of a respected business journalist. He is the author and editor of Plan B Economics, a source for insights into finance and economics. Follow him on Twitter for free eBooks, documentaries and more: ;@planbeconomics

This article first appeared in the April 2012 edition of Peter Schiff's Gold Report, a monthly newsletter featuring original contributions from Peter Schiff, Casey Research, and other leading experts in the gold market. Click here for your free subscription.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules