Investors should remember that real interest rates are much more important to the gold market than changes in nominal interest rates. Let’s see why.
Interest rates quoted on markets are nominal, so you usually need to adjust them for inflation. Inflation determines the difference between nominal and real interest rates. Nominal interest rates represent rates before taking into account inflation, while real rates are nominal rates adjusted for inflation.
Because there are different indices of inflation, there are also many measures of real interest rates. However, analysts often use the yields of Treasury Inflation Protected Securities (TIPS), which are indexed to inflation (CPI) and their face value increases with inflation, as a benchmark for real interest rates.
Real Interest Rates And Gold
In general, real interest rates are negatively correlated with the price of gold, i.e. rising real rates hurt the yellow metal. The reasoning behind this is that higher interest rates mean higher opportunity costs of holding non-interest-bearing assets, such as precious metals, making them relatively less attractive.
Gold pays neither dividends nor interest. Therefore, it is relatively expensive to hold when real interest rates are high and relatively cheap when real interest rates are low. In other words, the higher the interest rates, the higher the carrying costs.
However, the relationship is not linear. Gold prices tend to rise significantly only during periods of negative real interest rates. This is because negative interest rates, i.e. the situation where the inflation rate is higher than the nominal interest rate (the rate that is paid), means that creditors are losing money, so they are more inclined to buy gold.
In other words, gold then recovers its traditional role as money and a store of wealth, which will at least keep pace with inflation to preserve the purchasing power of capital, while bonds guarantee a real loss at interest rates. negative reals.
Some historical examples
What has happened in the past tends to confirm the unfavorable relationship between real interest rates and gold prices. In the second half of the 1970s, both nominal interest rates and inflation rates were high. What’s important is that inflation has outpaced nominal bond yields, so investors have shifted their capital into gold. While real interest rates were negative, the price of gold rose, reaching its all-time high.
The Role Of Central Banks
When Paul Volcker, the then chairman of the US Federal Reserve raised short-term nominal interest rates and real interest rates returned to positive territory, the gold boom ended. Interestingly, the significant downtrend in the gold market continued until 2001, when the Fed, seeking to reinflate an equity bubble, cut nominal interest rates so much that real interest rates fell to zero.
The consolidation since mid-2006 has been driven by rising real interest rates. However, in late 2007 the Fed lowered nominal rates again, so real rates plummeted and the price of gold skyrocketed at the same time.