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Wednesday, August 1, 2012

Negative Real Interest Rates Argue for New Highs in Gold

At any given point in time there are several variables that affect the price of gold. There are times when gold’s price is driven by its perceived association with inflation and other times it’s seen as a “safety asset” or even a global currency. One variable in particular that was a constant driver of gold’s bull market in the 1970s was the presence of negative real interest rates—where inflation rates are higher than nominal interest rates—which means savers who park their cash at the bank are seeing their purchasing power eroded. The power of negative real interest rates as a major catalyst for gold has also been dominant in gold’s secular bull market this time around and currently argues for new highs. However, the USD’s strength at present has been keeping gold in check. That may soon change if the Euro begins to stabilize and money flows back out of the USD.

Gold Variables

As mentioned above, one of the strongest correlations to the price of gold is not the USD but actually real interest rates. This can been seen below in which the top panel shows the open interest for gold futures contracts, the middle panel shows gold along with real interest rates (inverted in red), and the bottom panel shows the USD Index along with gold (USD Index shown inverted for directional similarity). Real interest rates in the middle panel have had the most consistent relationship with gold over the years but that changed in the middle of 2011 when the USD Index began to rise (fall in bottom panel below), despite real interest rates falling to new lows which suggested gold should be hitting new highs.
gold variables
Source: Bloomberg
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