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There are many reasons why gold is still our favorite
investment – from inflation fears and sovereign debt concerns to
deeper, systemic economic problems. But let's be honest: It's been rising for
over 11 years now, and only the imprudent would fail to think about when the
run might end.
Is it time to start eyeing the exit? In a word, no.
Here's why.
There's one indicator that clearly signals we're still
in the bull market – and further, that we can expect prices to continue
to rise. That indicator is negative real interest rates.
The real interest rate is simply the nominal rate minus
inflation. For example, if you earn 4% on an interest-bearing investment and
inflation is 2%, your real return is +2%. Conversely, if your investment
earns 1% but inflation is 3%, your real rate is -2%.
This calculation is the same regardless of how high
either rate may be: a 15% interest rate and 13% inflation still nets you 2%.
This is why high interest rates are not necessarily negative for gold; it's
the real rate that impacts what gold will ultimately do.
What History Tells Us
The chart below calculates the real interest rate by
extracting annualized inflation from the 10-year Treasury nominal rate. Gray
highlighted areas are the periods when the real interest rate was below zero,
and as you can see, this is when gold has performed well.
Gold climbs when real interest rates are low or
falling, while high or rising real rates negatively impact it. This pattern
was true in the 1970s and it's true today.
A closer study of this chart tells us there's actually
a critical number for real rates that seem to have the most impact on gold.
Take a look at how gold performs when real rates are at 2% or below.
The reason for this phenomenon is straightforward. When
real interest rates are at or below zero, cash or debt instruments (like
bonds) cease being effective because the return is lower than inflation. In
these cases, the investment is actually losing purchasing power
– regardless of what the investment pays. An investor's interest thus
shifts to assets that offer returns above inflation… or at least a
vehicle where money doesn't lose value. Gold is one of the most reliable and
proven tools in this scenario.
Politicians in the US, EU, and a range of other
countries are keeping interest rates low, which, in spite of a low CPI,
pushes real rates below zero. This makes cash and Treasuries guaranteed
losers right now. Not only are investors maintaining purchasing power with
gold, they're outpacing most interest-bearing investments due to the rising
price of the metal.
Here's another way to verify this trend. As the
following chart shows, from January 1970 through January 1980 gold returned a
total of 1,832.6%. This is much higher than inflation during that decade,
which totaled 105.8%.
In the current bull market, gold has gained 556.3% since
2001, while inflation has thus far totaled 30%.
Further supporting this thesis is the fact that when
real rates are positive, gold has not performed well. You can see this in the
following chart of when real interest rates were higher than inflation.
The gold price fluctuated between $300 and $500 for the
twenty-year period when rates were positive. This is a strong reminder that
bull markets don't last forever – even golden ones – and that at
some point we'll need to sell to lock in a profit.
So if history demonstrates that gold does well during a
negative-rate environment and poorly during positive periods, the natural question
becomes…
How Much Longer Will Negative Real Rates Last?
US Federal Reserve Chairman Ben Bernanke stated in
January that he expects to keep short-term interest rates close to zero
"at least through late 2014." This low-rate, loose-money policy is
intended to "support a stronger economic recovery and reduce
unemployment." While his strategy is debatable, this implies that almost
any inflation at all will continue to keep the real rate negative and thus
gold will stay in a bull market.
What if the economy improves? After all, there are
economic data showing the economy may be finding its footing, making some
believe interest rates could be raised earlier, as soon as next year. Based
on the data above, the answer to the question is, "What does inflation
do?" In other words, interest-rate fluctuations alone aren't important;
it's how the rate interacts with the inflation rate. If inflation
simultaneously rises and keeps the real rate negative, we should expect gold
to remain in a bull market.
With the obscene amount of money that's already been
printed, high inflation seems almost certain at some point, even if there
isn't any more money creation. This is why we think the end to the gold
bull market is not yet in sight.
One more point. You'll notice in the above charts that
this trend doesn't reverse on a dime. It takes anywhere from months to years
for investors to shift from interest-bearing investments to metals –
and vice versa. And the longer the trend, the slower the change. Real rates
have been negative for a decade now, and with broad institutional investment
in gold largely still in absentia, it seems reasonable to expect that
the trend in gold won't shift anytime soon.
Implications for Investors
Armed with these data, there are definite steps you can
take with your investments at this point, as well as reasonable expectations
you can have going forward:
- You can buy gold today. As long as real interest
rates are negative, gold will remain in a bull market. If you already
own some gold, you can and should ask yourself if it's enough at a time
when money in the bank is a losing proposition.
- Don't get flummoxed when you hear talk about
rising rates. Watch the real rate instead.
- our opinion, real rates will be negative for some time
for the simple reason that we think inflation will be rising for some
time. Ask yourself: Will the Fed and other central banks raise rates
aggressively enough to catch up to inflation? Someday, sure… but
not anytime soon.
- When real rates turn positive, especially above
2%, it may be time to sell. We'll have to see what's going on in
the world at that time; if there's financial chaos, the fear factor
could cause gold to depart from this historic pattern. But even if not,
keep in mind that while the price of gold
fluctuates every day, the shift out of gold-based investments won't
occur overnight. There should be time to gain clarity.
There are a lot of reasons to own gold today, and there
will likely be more before it's time to say goodbye. In the meantime, we take
comfort in the fact that the strongest historical indicator of all tells us
the gold bull market is alive and well and has years
to play out.
Carpe aurum.
[To learn more about the best ways to invest in gold
today and in the months ahead, you won't want to miss this free call with two
of Casey Research's seasoned metals analysts: Gold Investing in 2012 and Beyond: Your Questions
Answered! Hurry if you want to get in on it – at midnight
EDT on April 6, signups will close.]
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