The Price of Gold Could Be Repeating History – Here’s Why

…With inflation picking up (consumer prices in the U.S. rose 0.9% year-on-year in March of 2016) but the Fed unable to hike because of the significant global volatility in January and February, RBC speculates that there are now growing parallels to the 1970s when external pressures and fragile growth rates did not allow the Fed to hike. This was also notably a time of strong gold price appreciation. [Could the gold price be repeating history?]

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Gold price: Repeating history 

As US monetary policy remains accommodative and inflation ticks higher, the potential for lower real interest rates is increasing. The last time such an anomaly was seen in the markets was back in the 1970s. During this period, inflation and inflation expectations shot higher although there was little that could be done to cool inflation from a monetary policy perspective as any rate…[hike] would have likely led to a serious recession. Spiking inflation and stagnant interest rates caused real interest rates to fall below the neutral 2% level and even moved sharply negative for a short period. Gold rose from $125/ozt. in 1976 to a peak of $800/ozt. in 1980.

In a normal environment, when inflation expectations are positive, but contained or falling, real interest rates have tended to be positive. In an environment such as this, the cost of owning gold is equal to this real interest rate or what is being given up vs. other yielding assets after inflation. When real interest rates are negative the cost of owning gold declines, driving higher demand for the yellow metal, leading to higher prices. RBC’s data shows:

“Since 2008, the correlation between gold and real interest rates (using 10 yr US bond yields and 5yr5yr inflation swaps as a proxy for medium-term inflation) has been high. The R-squared is 60%, with higher correlations in periods of rapid movements in real rates. This high correlation makes logical sense in a period of lower interest rates as well as lower inflation expectations. In 2012-2013, the expectations that monetary policy was on the cusp of normalising (or at least normalising over the longer-term) saw a sharp recovery in real interest rates and a declining gold price. This coincided with the sharp selloff of gold ETFs in 2013.”

Based on historic trends, prices and fundamentals RBC uses a regression analysis, which looks at the relationship between a dependent variable and one or more independent variables, to compute that a negative 0.5% real rate level would suggest a gold price of $1,380/ozt. and a negative 1.0% real rate level would suggest a gold price $1,546/ozt.

What’s more, if market forces continue to hold down US Treasury yields in the face of rising inflation, this could create a 1970s-esque phase in real rates in the short-term. The data suggests that such an environment would lead to higher gold prices although it remains to be seen if prices can repeat their record-breaking 1976 to 1980 run higher.

Disclosure: The original article, by Rupert Hargreaves (ValueWalk.com), was edited ([ ]) and abridged (…) by the editorial team at munKNEE.com (Your Key to Making Money!) to provide a fast and easy read.

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