On Tuesday (August 11), gold fell by nearly US$50 from its daily high, falling below the US$2,000 mark, and refreshing its low of more than a week to US$1983.70. The optimistic news about the vaccine and the rebound of the US dollar index pressured gold prices.
However, with the recent US 10-year bond’s actual yield falling to -1%, the market is betting that the US bond’s actual yield will fall further. According to historical data, the real yield of U.S. Treasury fell to negative values in the 1940s and 1970s, when it reached the lowest level of -3%.
Considering that the Fed’s unprecedented stimulus measures this year may further push down the actual yield, some analysts believe that the actual yield may further fall to -4%. In this case, even if the short-term correction, gold will continue to rise further in the later period.
The 2008 Nobel Prize winner in Economics Krugman believes “The rise in gold is due to the decline in bond yields, and the sharp drop in bond yields reflects economic pessimism.”
The real interest rate (nominal interest rate-inflation rate) is currently at -1%, and it looks like it will fall further. But this is not the first time that real interest rates in the United States are negative. They have been negative during the post-World War II era in the 1940s and the stagflation period in the 1970s.
The fall in real interest rates can sometimes be a deliberate policy to reduce the government’s debt burden, because the real value of debt falls as negative real interest rates rise. A policy of negative real interest rates is always preferable to a painful policy of allowing companies to go bankrupt.
The policy response of the United States is to print a large number of accounts on the money to rebuild the banking system and avoid defaults. As the US M2 growth rate reaches 23%, and there is no opportunity to raise policy interest rates in the next few years, real interest rates may fall further in the next few years.
When real interest rates fall, the value of gold tends to rise, because gold is a permanent zero coupon bond, and holding zero coupon assets is better than holding assets with negative real interest rates (such as U.S. Treasury bonds), the latter’s issuance is unlimited. Negative real interest rates also mean that you need to be an asset owner to maintain the purchase value of depreciating banknotes.
Just as the real interest rate moved from -3% to -4% from 1942 to 1951, if this is the expected real interest rate, is there a mathematical method to find the value of gold in this environment?
Analysis by Ven Ram, currency and interest rate strategist at Bloomberg Markets, shows that when interest rates rise, the duration of gold is 17 years, and when the yield falls, the duration of gold is 20 years, which indicates changes in interest rates. The second derivative of is very active. Back in 2018, Pacific Investment Management Company (Pimco) found that this period was almost 30 years.
The price of gold has been rising this year, and the price of gold has soared 35% due to the 120 basis point drop in real interest rates.
Other catalysts includes low global production, general erosion of confidence in global fiat currencies, especially the weakening of the US dollar, uncontrolled global currency and fiscal stimulus, investors buying through gold ETFs in response to the uncertainty of the evolution of the epidemic.
However, once the price of gold rises to around US$2,500 per ounce, the outlook becomes blurred. Exceeding this level means that real interest rates have fallen too much, and interest rates will rebound more sharply than we have already seen.
Correlation analysis shows that these factors also mean that the nominal yield on 10-year US Treasury bonds has fallen sharply, which is currently about 0.50%. This actually means that the market has begun to set prices for the recession. Studies have shown that if the actual rate of return drops to -3.15%, gold may be pushed to $3,000.
Given that gold has a longer life than related assets, gold provides a way to balance the economy to hedge against inflation.
The real interest rate in the United States will fall below -3%, eventually reaching a level similar to the average real interest rate of -3.14% in the 1940s.