…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?]
Stop clicking around! #Follow the munKNEE instead
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 (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.
“Follow the munKNEE” on Facebook, on Twitter or via our FREE bi-weekly Market Intelligence Report newsletter (see sample here , sign up in top right hand corner)
Related Articles from the munKNEE Vault:
I think the time is right to buy gold and precious metals mining company equities. Profits over the next five years should be enormous, but one caveat remains. Governments will villainize those of us with foresight by claiming that we are the cause of the grief and turmoil faced by our fellow citizens. Their answer will be to impose usurious tax rates frequently called ‘windfall profits taxes’.
Higher gold prices look both reasonable and inevitable. Fifty years ago gold sold for under $40. Gold selling for over $4,000 does not seem unlikely. Depending on the unfolding “insanity” in our political and financial world, $4,000 might be considered quite low in 5 – 10 years.
A weakening U.S. economic recovery, falling profit and revenue, the effect of the high U.S. dollar on multinational earnings, valuations not seen since the days of the dot-com bubble—they all point to a lower stock market. What does this mean for gold?
After two years of declines, many investors sold their gold holdings and vowed never to invest in gold again. However, in the fall of 1976, gold began an ascent that saw it rise 750%, peaking at $850 a troy ounce three years and four months later. After a 3-year correction, the same opportunity to buy low exists today, just as it did in 1976.
The future price of gold is very much dependent upon the reactions of governments and central banks regarding the current deflationary forces. $3,000 – $5,000 per ounce is quite possible at some time in 2020 – 2022, if not sooner.
Gold is in a hurry and is unlikely to wait for investors to acquire it at anywhere near these prices. We could now see a quick move to $1,400 and if gold doesn’t stay too long at that level, the acceleration is likely to continue towards the previous high of $1,900 and go even as high as $2,000/ozt. That being said, silver will move twice as fast as gold and could well reach $50 in 2016. Here’s why.