by Jim Rickards, Daily Reckoning:
Is the gold skid over? There are encouraging signs that the answer is yes. And, that’s great news for patient gold investors (especially those who bought the lows, as I recommended to my subscribers a few weeks ago).
First, some facts. Gold hit an all-time high of $2,069 per ounce on August 6, 2020. Since then, it has been on the skids, despite occasional rallies. The low in this cycle was $1,678 per ounce on March 8, 2021.
The reason for the skid was not hard to discern.
It’s often the case that gold prices get pushed around by a number of factors, including real rates, nominal rates, geopolitical concerns, inflation and simple supply and demand.
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But, this decline had only one factor — rising nominal rates on the ten-year Treasury note.
Ten-year note rates hit an interim low of 0.508% on August 4, 2020, right around the same time gold peaked. From there, rates began a relentless march higher. The nominal yield on the ten-year note peaked at 1.745% on March 31, 2021.
The rate/gold inverse correlation was extremely high. As rates climbed from August to March, gold fell. Nothing else mattered, including the election, the Capitol Hill riots or Biden’s confiscatory tax plans.
Rates rose, gold fell, enough said. The question for analysts was, why were rates rising?
Gold Isn’t Supposed to Offer Yield
Again, the explanation was simple. Markets were watching the $900 billion Trump bailout in December, the $1.9 trillion Biden bailout in early March, and the announcement of plans for another $3 trillion bailout later this year.
The reasoning was, with that much money being pumped into the economy and with output capacity still limited by the pandemic shutdowns, inflation must be right around the corner. Rates rose in anticipation of inflation from all of the bailout spending.
When rates rise, gold often falls because Treasury securities and gold compete for investor dollars. As rates rose, the Treasury notes became more attractive, and gold less so because gold has no yield.
By the way, some people criticize gold because it doesn’t offer any yield. But gold is not supposed to have any yield because it’s money; you only get yield when you take risks on securities, money markets or bank deposits. But that’s a story for another day.
Still, there was a conundrum at the heart of this inverse correlation.
Sure, rising rates might make for competition for investor allocations that hurts the price of gold. But, if rates were rising because of inflationary expectations, wouldn’t gold rally because of the inflation?
Ah, the plot thickens…
Gold Sees Further Than Any Other Asset
To resolve the conundrum, we have to bear in mind that gold has a better track record of predicting economic developments than any other asset class. Gold looks so far ahead that investors often cannot see what the gold price is saying.
The point is that rates were rising on inflationary expectations, but there was no actual inflation. Hard data (as opposed to Wall Street analysis) showed that most of the bailout money was not being spent.
Over 76% of the bailout money was used either for savings or to pay down debt (which is economically the same thing as saving). Neither saving nor debt repayment constitutes new consumption. And, without consumption, there is no velocity and no upward pressure on prices.
In short, interest rates were predicting inflation, but gold prices were saying: Not so fast!
This wasn’t our first interest rate fake-out. The 10-year note hit 3.96% on April 2, 2010. It then fell to 2.41% by October 2, 2010. It spiked again to 3.75% on February 8, 2011, before falling sharply to 1.49% on July 24, 2012.
It spiked again, hitting 3.22% on November 2, 2018, before plummeting to 0.56% on August 3, 2020, one of the greatest rallies in note prices ever.