Long-term Interest Rates and Gold

By Walter Kurtz, Sober Look

“What’s the correlation between long-term treasury yield and gold price?” was an e-mail question from one of the Sober Look readers recently. The answer of course is – it depends. During periods of inflationary pressure, inflation risks tend to drive yields and gold in the same direction (bond prices and gold move in the opposite direction.) That is why historically gold was viewed as a strong hedge for traditional assets. Here is an example covering one of the periods when inflation was a major concern: 1978 – 1979 (24 months).

78-79 treasury yield vs gold price

 

The relationship looks dramatically different over the last couple of years, with two different regimes visible over the period. The link between the two asset classes prior to April 2013 was quite weak, with no consistent correlation in their movements. But after April, the correlation between rates and gold price turned negative.

last two years treasury yield vs gold price

 

What happened in April that forced a switch to the new regime? On April 10th Goldman became bearish on gold due to (among other things) expectations of economic improvement in the US and risks of rising real rates (see Fox News story). Below is part of Goldman’s report.

GS (April 10, 2013): – Over the past month, events in Cyprus triggered a rise in Euro area risk aversion while US economic data has been disappointing. Remarkably, gold prices are unchanged over that period, although US 10-year TIPS yields are back at their lowest level since late 2012, highlighting how conviction in holding gold is quickly waning. This is particularly visible at the ETF level, with gold holdings continuing to decline quickly. Given gold’s recent lackluster price action and our economists’ expectation that the acceleration in US growth later this year to above trend pace will see US real rates move gradually higher, we have lowered our USD-denominated gold price forecast once again. Our new forecast is further below the forward curve, with year-end targets of $1,450/toz in 2013 and $1,270/toz in 2014.

Some other investors and analysts started shifting their views in that direction as well. That was the turning point. Expectations of rising real rates, driven in large part by the trajectory of the US economic recovery and subsequently the Fed’s next steps, began to move both gold and treasury prices in the same direction.

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Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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Comments

  1. The price of gold is driven by what REAL interest rates are. E.g. in an Hyper-Inflation REAL interest rates become and stay negative and that’s good for gold. When rates go through the roof and “inflation” remains (comparatively) tame (like in the very late 1970s) then that’s a negative for gold.
    2. Investment demand for gold is also good for gold and then it doesn’t matter less what rates are.

    More over, the notion that inflation on its own and “inflation risks” and “inflationary pressures” drive interest rates is also nonsense. Rates are simply the product of supply & demand of capital. Nothing more, nothing less.

  2. The gold price pivots on whether the real short-term interest rate is above or below 2%.

    Obligatory:

    http://www.crossingwallstreet.com/archives/2010/10/a-model-to-explain-the-price-of-gold.html

    http://econompicdata.blogspot.com/2010/10/on-value-of-gold.html

    http://econompicdata.blogspot.com/2011/08/gold-model-still-rockin.html

    http://www.crossingwallstreet.com/archives/2012/09/notes-on-my-gold-model.html

    http://www.crossingwallstreet.com/archives/2013/05/so-i-guess-gold-was-right.html

    “Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%….there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.”

  3. Correct — this year’s sell off wasn’t initiated by GS, it coincided, almost to the day, with real yields ticking positive (primarily due to inflation, and inflation b/evens) dropping.

  4. There are technical problems with taking correlations between prices or price and rates. Its better to do correlations between returns and rates, or maybe returns and change in rates.