There’s no fever like gold fever.
It’s true. There’s nothing else financially like it.
Stock prices, for example, are driven up by greed and driven down by fear. Market prices for every other investment is the same.
Gold is the exception. It’s price it driven up by both fear and greed.
As a result, when gold prices run, they run massively.
That’s why now -- with gold in a new uptrend and nearing $1300 an ounce -- is the time to look at gold again.
There’s No Fever Like Gold Fever
Gold’s run over the last few months has been strong.
The price of an ounce of gold has jumped well over $200 an ounce so far this year, sentiment has completely turned around, and, if the amount of “Buy Gold Now” ads getting served to me by Google are any indicators, investors are piling back into into it.
But here’s thing about gold: buying and selling it (and gold stocks) profitably requires taking all the emotional fear and greed out of gold and looking at one simple factor which is the most important determinant of long term gold prices.
You see, the real driver of gold prices is interest rates.
More specifically, real interest rates.
Never heard of them? That’s fine.
Today we’ll see what they are and how they incorporate all the factors affecting gold prices -- like government debt levels, inflation, currency confidence, etc. -- into one number.
Negative real interest rates are pretty simple once you break it down.
Let’s start with interest rates. They’re easy to find. Just pull up a quote for the yield on the 10-Year Treasury Bond, the benchmark interest rate for the entire world. It’s 1.75% as I write.
To determine the “real” interest rate, you just have to subtract inflation from that.
The benchmark inflation rate is the Consumer Price Index (Urban) Excluding Energy And Food (we’ll just call this index the CPI from here on).
The CPI over the last 12 months has been 2.1%.
Those two data points are all we need to find real interest rates - the current nominal interest rate of 1.75% and the current rate of inflation is 2.1%.
Again, to find the “real” rate you just subtract inflation from the nominal rate of interest.
So the current real interest rate is negative 0.35%.
That basically means, if you bought a 10-Year Treasury bond today and inflation stayed the same, you would lose 0.35% of value each year for the next 10 years.
Sound like a good investment? Hopefully not.
That’s the problem when real interest rates turn negative. There are almost no safe places to hide. Your savings will lose value in when real interest rates are negative. As a result, gold becomes the only safe store of value.
Now, I realize that’s a pretty convoluted theory. And we’ve looked at quite a few theories in the past. Few of them work. In this case, however, the reason I asked you to read about this is because this actually works incredibly well.
Take a look at the following charts to see.
First is the 10-Year U.S. Treasury Yield:
Second is the rate of inflation:
Third is the price of gold:
All of those charts are pretty straightforward.
Just looking at them individually it’s pretty tough to see a clear pattern.
So in the next set of charts I’ve combined the first two (interest rates and inflation) and put the gold price chart right below it.
You should be able to spot a pattern now:
Note the top chart. When the rate of inflation (blue line) reaches the interest rate on the 10-Year U.S. Treasury Bond (red line), real interest rates have turned negative.
Now look at those few times real rates went negative and what happened to the price of gold.
Without fail, gold soared when interest rates turned into negative territory.
In the 1970s gold ran from $100 an ounce to more than $900 an ounce after a long period of extremely negative real interest rates.
Between 2003 and 2008 the real rate of interest dropped steadily and when negative in 2008. Gold ran from $300 an ounce to more than $1000 over that period.
In 2008, interest rates plummeted but inflation dropped even faster. As a result, the real interest rate turned sharply positive. Gold prices dropped from more than $1,000 to less than $800 over that time.
Then, after the Federal Reserve committed to Quantitative Easing and inflation started to rise and interest rates fell, the real rate of interest went negative again. Gold soared to $1900 an ounce because of it.
The pattern is pretty clear here. Pretty much undeniable.
Anyone looking at these charts would see that real interest rates are the most important factor driving gold prices over the long-term.
Right now, with central banks threatening negative nominal interest rate and doing all they can to spark inflation (to inflate away massive private and public debt loads), they are committed to keeping real interest rates negative for the foreseeable future.
The gold bull market, in those conditions, would continue it’s climb.