Why Gold Is Likely to Continue Lower
If stocks and other risky assets turn lower and short-term rates become even more negative, gold may be able to break out of its bear market.
What did appear to be significant were what I dubbed “pseudo-real” short-term interest rates, the difference between one-year Treasuries and the trailing rate of reported inflation, and the downward deviation of long-term interest rates produced by Operation Twist and its various QE supplements. Gold could rise if the short-term pseudo-rates fell, which was difficult to achieve when nominal rates were near 0% and reported inflation was declining. It could also rise if the yield curve steepened bearishly and made long-term financial assets such as stocks less attractive. As stocks have been in an uninterrupted bull market since the end of November 2011, that was a difficult hurdle for gold to overcome.
Twist and Peak
As before, let’s map the total returns for the Dow Jones-UBS Gold Subindex against those for both 7-10 year Treasuries and high-yield corporate bonds across four different monetary regimes:
2. August 2007 to the adoption of 0% interest rates on December 16, 2008;
3. December 2008 to the August 10, 2011 twist announcement; and
4. Post-August 2011.
I noted the following in April:
In the case of 7-10 year Treasuries, the relationship between the first and third periods is statistically identical; the financial crisis period understandably was different. However, all three of these periods had a positive relationship; the current one is different from the others with near-100% confidence.
This has changed now as long-term interest rates have increased and are likely to remain under some modicum of upward pressure as the Federal Reserve will be printing only $75 billion per month as opposed to $85 billion per month. The restoration of a positive correlation is the good news for gold; the bad news is that correlation is positive by virtue of both gold and long-term bonds sporting negative returns.
The map is different for high-yield bonds as could be expected given the risk-seeking effects of artificially low long-term interest rates. The negative relationship prevailing in the post-August 2011 twist period remains intact.
Negative Real Rates
The real rate for 10-year Treasuries in April was -0.568%; it has increased to 0.755% at the time of this writing, and real Treasury rates are negative “only” out to the six-year horizon. If these real rates keep rising out of surging credit demand and a restrictive supply of funds, we would have to regard it as a negative for risky assets. If – and I say this as a statement and not as a forecast – stocks and other risky assets turned lower and demand for short-term instruments surged to the point where short-term rates became even more negative, then gold’s bear market could end.
Restated, gold’s best hope is for the rest of the world to roll up in a ball and die. I will leave it to others to decide whether true gold bugs would be pleased at this outcome. Otherwise, look for gold to continue moving lower.
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