What The Economist Doesn't Know About Gold

By: Adrian Ash | Wed, Jun 23, 2010
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Two things happen to cash savers (meaning pretty much everyone) when real interest rates get stuck below zero...

HOW HAS GOLD reached and breached new all-time highs in the absence of strong 1970s-style inflation?

The Buttonwood column in last weekend's Economist is only the latest analysis to miss the point, and despite tripping right over it, too.

"Owning gold is traditionally seen as offering protection against inflation. And inflation is very bad news for owners of government bonds.

"But the ten-year Treasury bond yields just 3.3%, a level that is towards the low end of the historical range...You would expect the performance of gold and Treasury bonds to be inversely correlated. When gold was at its real all-time high in 1980, the ten-year Treasury-bond yield was 10.8%. Fixed-income investors had suffered years of negative real returns in the 1970s."

But there's the rub, as we never tire of telling people here at BullionVault. They tire so quickly of hearing it, however, that even The Economist can't square the circle of rising gold, falling bond yields. Because it never was inflation alone in the '70s that drove people to buy or sell a lump of rare, indestructible metal. It was rather the rate of return offered by cash and bonds - those better competitors as a store of wealth, all things being equal - over and above (or below) inflation.

Real 10-Year US Treasury Bond

That's why gold made a terrible inflation hedge in the 1980s and '90s, most especially for Dollar investors. Because no-one needed an inflation hedge! Not when 10-year Treasuries paid 4.3% on average over and above CPI inflation. Not when the real Fed Funds rate averaged 3%-plus...leaving gold to drop three-quarters of its real Dollar value inside 20 years...as the real value of cash-on-deposit doubled.

Now compare and contrast with the last eight-and-a-half years. CPI inflation has averaged barely half its previous two-decade average, yet the real returns paid to bonds and cash have collapsed. Adjusted for inflation, in fact, the real Fed Funds rate has now been below zero for 54 of the last 101 months. That matches the 54 months of sub-zero real rates which the Fed delivered in the 1970s...

Fed Funds Rate minus Inflation

...but things are worse yet, of course. First because that decade's 54 months of negative real rates were spread across 10 full years from Jan. 1970. So second, the overall effect on the average real rate since 2002 has been to drive it lower again.

Real Fed Funds Overall ave. real rate Neg. months Neg. ave.
1970-1980 0.01 54 -1.49
2002 to date -0.12 54 -1.37

Short of a revolution in Fed thinking (no sign of that today), the decade starting Jan. 2002 looks set to deliver yet more negative real rates before 2012, if not beyond. Which will continue to mean that:

The monetary metals may not have been official money for many decades today. But the Fed's interest-rate policy is actively leading the remonetization of gold and silver as popular stores of value.

Because when "risk free" cash keeps paying a guaranteed loss, then a growing number of people will, in due course, start seeking shelter elsewhere. At the same time, holding gold and/or silver has ceased being a burden (bullion storage rates need not be onerous), inviting fresh flows of retained capital, tired of earning nothing or less.

Real returns to cash have now been low-to-negative for almost a decade, and so it might not be too long before a far broader, and thus larger, volume of savings turns from cash to the obvious and historic alternatives. Either that or the Fed will hike rates so high, you get 4% and more above inflation.

 


 

Adrian Ash

Author: Adrian Ash

Adrian Ash
BullionVault.com

Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK's leading financial advisory for private investors, Adrian Ash is the head of research at BullionVault, where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

About BullionVault

BullionVault is the secure, low-cost gold and silver exchange for private investors. It enables you to buy and sell professional-grade bullion at live prices online, storing your physical property in market-accredited, non-bank vaults in London, New York and Zurich.

By February 2011, less than six years after launch, more than 21,000 people from 97 countries used BullionVault, owning well over 21 tonnes of physical gold (US$940m) and 140 tonnes of physical silver (US$129m) as their outright property. There is no minimum investment and users can deal as little as one gram at a time. Each user's unique holding is proven, each day, by the public reconciliation of client property with formal bullion-market bar lists.

BullionVault is a full member of professional trade body the London Bullion Market Association (LBMA). Its innovative online platform was recognized in 2009 by the UK's prestigious Queen's Awards for Enterprise. In June 2010, the gold industry's key market-development body the World Gold Council (www.gold.org) joined with the internet and technology fund Augmentum Capital, which is backed by the London listed Rothschild Investment Trust (RIT Capital Partners), in making an $18.8 million (£12.5m) investment in the business.

For more information, visit http://www.bullionvault.com

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