This guest editorial is by Justin Spittler, Hard Assets Alliance Analyst
The announcement by Bernanke & Co. that the Fed would stay the course with its asset-purchasing program until it sees more evidence of a strengthening economy sent shock waves across the investment world. The Dow and S&P 500 has rocketed to all-time highs, and the dollar has plummeted. Interest rates have been dealt a stiff blow.
Though labeled as “stunning” by the mass media, the decision by the Federal Reserve supports what many in the alternative economics camp have been saying for years, which is that the American economy would come crashing down if the Fed were to scale back its monetary life support.
The very mention of the Fed tapering its asset-purchasing program was enough to send long-term Treasury rates on an historic upward march. While the Fed stated that it will not increase yield until 2015 or later, higher rates are ultimately inevitable given the unprecedented expansion of the US money supply.
In light of recent events and the historical, negative 82% correlation between gold and US real rates, I imagine many of our readers out there are interested, if not concerned, about how the yellow metal will fare when rates eventually do snap back to reality.
Relationship Between US Real Rates and Gold Deteriorating
Conventional wisdom suggests that higher rates are bad news for gold. However, as detailed in a recent special report by the World Gold Council, an environment of rising rates is not necessarily a death sentence for the yellow metal. In fact, excluding the high real-rate environment of the late 1970s and the early 1980s, US real rates have actually exerted little influence on gold prices. Going forward, this is more likely than ever to be true, due to the dramatic evolution of the gold market over the past two decades, which has been highlighted by a shift of influence from the Western to the Eastern world.
Though it stings of cliché to say it, the reality of the situation is that this time is different. Whereas higher interest rates may once have been enough to send gold prices into a tailspin, today’s gold market is marked by a weaker US dollar as well as the overwhelming majority of gold demand originating from China and India. Furthermore, when higher rates do eventually manifest, it will not likely be due to an improving economy but rather because of elevated risk perceptions associated with US debt. Given the market’s ongoing transformation, we remain bullish on gold in both a rising and falling interest-rate environment.
Although the relationship between US interest rates and gold has deteriorated significantly, benchmark yields will likely continue to influence price volatility, especially in the paper market, due to the size and liquidity of Western markets. However, as we like to stress, investing in gold is all about understanding the big picture, and there is no better way to play the fundamental forces acting upon gold than to take possession of physical product.
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