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Real Rates Set the Pace for Gold

Inflationary expectations are a weather vane.

“History doesn’t often repeat itself, but it often rhymes.” That pithy bit of business is reputedly Mark Twain’s. Whether he actually said it or not is of no consequence to us today. What matters is that it’s true. 

It’s true of a lot of things: world conflicts, engine mechanics and the price of gold.

We’ll leave geopolitics and automotive technology behind for now and concentrate on bullion. Back in March, we examined the connection between gold and inflation (see “Gold’s Relationship With Inflation”) and discovered the link to be more nuanced than many people think. In a nutshell, gold’s not really an inflation hedge. It’s bonded more with real interest rates. Since real interest rates are determined by implied levels of inflation, there is a tie with gold but it’s indirect at best.

The bottom line? If real rates rise, gold likely falls. Bullion heads higher as real rates decline. You can see relationship between rates and metal in the chart below. Real rates are portrayed inversely on the lefthand scale while gold prices are indexed on the righthand side. Notice the correlation?

After the March column was published, gold and real rates fibrillated through the spring and summer. In late August, bullion prices broke above the $1,300 level as the 10-year real Treasury yield slumped below 40 basis points (0.40 percent).


Still, neither bullion nor real rates could penetrate their trend lines. So far, the longer-term trends are intact. The good news for gold bulls is that there’s a trend channel established for real rates—scribed by the red dashed lines on the chart above—that sets a stage for declines. Keep in mind that it’s just stage setting, not a guarantee. There’s still overhead resistance from the 2011 top that gold must be overcome. And 10-year real rates are still supported by the trend established by the bottom in late 2012.

If inflationary expectations rise at a slower pace than nominal yields—as they have in recent days—real rates will rise and gold will likely continue to decline. A gold reversal to the upside will be heralded by inflationary expectation heating up more than Treasury rates.

Advice to gold aficionados: If the gold trend seems confusing, look to the trajectory of real interest rates before making tactical adjustments to your positions.


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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