The Market's Measure
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Look REAL Close at Interest Rates

Inflation-adjusted yields may be the key to gold prices.

“Gold’s an inflation hedge.” How often have you heard that old saw? And is it really true?

Perhaps if you take the long view, it is true. But you have to take an exceptionally long view to see this.

Since the dollar was allowed to float free of gold in 1971, the Consumer Price Index has climbed to over 500 percent. In that same time, gold’s price has risen about 3,000 percent. Bullion’s eye-popping return certainly seems to have beaten the dickens out of inflation over the past 47 years. But here’s the deal: What if your hedging horizon is less than four or five decades?

Check the chart below and you’ll see periods where gold seriously underperformed inflation. The interregnum between November 1980 and July 1982 saw a 74 percent drubbing of the gold price as the CPI rose 13 percent. Between March 1996 and January 2001, gold sank 34 percent while the CPI climbed 12 percent. Then there was the period between November 2012 and December 2015. Gold gave up 46 percent then. Inflation was tame at that time, creeping up less than 3 percent.

Overall, there’s only a 17 percent correlation between the inflation index and gold’s price. For a hedge, that’s not a good fit.  Hedging is time-dependent: There are good times to hedge and there are bad times. Clearly, the true benefit of tying up assets with a gold hedge is derived when bullion turns bullish. Otherwise, assets like stocks or bonds—income-producers devoid of carrying costs—outpace inflation better.


That’s not to say that gold and inflation are unrelated. Gold is highly correlated to real interest rates and the reality of interest rates is determined by factoring in the effect of inflation, or inflationary expectations.

Inflationary expectations, measured by the Break-Even Inflation rate at least, have been pushed upward over the past six months. The BEI rate is the difference between the nominal yield on a conventional Treasury security and that of an inflation-protected note or bond of the same maturity. If inflation averages more than the BEI rate, the inflation-linked security will outperform the conventional note or bond. If inflation trends lower than the BEI rate, the traditional fixed-rate security will come out on top. It’s important to know that the BEI is just real-time expectation, not a forecast. 

At the end of August 2017, the 10-year BEI rate was 1.76 percent. By February’s end, the rate had clawed its way up to 2.13 percent as the tax cut package and its consequences became reality. 

If nominal yields rise faster than inflationary expectations, real yields go up. That’s typically bearish for gold. If the BEI rate outpaces conventional Treasury yields, gold tends to rise. Notice how closely the gold price trend hugs that of the inverted real yield trend. There are times—inflection points, really—when the trends briefly seem to diverge. (In actuality, since the real yield trend depicted here is inverted, they converge.) There was an excursion in late 2011 as gold started to slump while real rates continued to fall. Then, in October 2012, both trends broke. Gold plummeted as real rates rose for nearly a year.


We’ve recently come into another divergence period. The rise in real rates started to accelerate in December, peaking in February, as gold prices spiked. As the tax cut became a certainty, the yield on the 10-year Treasury note spiked 50 basis points, twice the run-up in the BEI rate.

As February wound toward March, though, the trend lines began to converge again. The question for traders is this: Is this convergence short-lived? Is one trend presaging a significant move in the other, as in 2011? Will real rates start moving higher in earnest? An overheating economy, stoked by full employment and flush with cash, would seem to make that a, um, real possibility.

Brad Zigler is WealthManagement’s Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange’s (now NYSE Arca) option market and the iShares complex of exchange traded funds.

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