Projected Price of Gold

Real Rates (nominal rate – inflation rate = real rate) are currently at negative 1% levels and it seems they may go down even lower. But they have been negative before during the 1940s in the post WW2 era and in the 1970s STAGFLATION.

The decline in real rates sometimes can be a deliberate policy to reduce the debt burden of government because the real value of debt falls with rising negative real rates. The policy of negative real rates is always preferred over the bitter pill of allowing companies to go bust.

The US policy response post-COVID has been to print loads to money to reliquify the banking system and avoid defaults. With the rate of US M2 growth reaching 23% and no chance of an increase in policy rates over the next couple of years, real rates are likely to fall further in the coming years.

When real rates decline, gold’s value tends to go up more because GOLD is a perpetual Zero-coupon bond. And holding Zero-coupon assets with limited supply is better than holding negative real rate assets like US treasuries whose supply is unlimited by issuance. A negative real rate also means that you need to be an hard asset owner to maintain the purchasing value of depreciating paper currency.

I strongly believe that we are like ( 1942-51 ) headed to -3% to -4% real rates and if that is the expectation on real rates is there a way of mathematically finding the value of GOLD in that environment?

While I was grappling with the question of having an input (-3 to -4%) value but not the output i.e value of GOLD at that level of negative real rates, there came along an article from the Bloomberg columnist on this subject.

The analysis by Ven Ram (currency and rates strategist for Bloomberg’s Markets) shows that the duration of gold is 17 when interest rates go up and 20 when real yields trend lower, suggesting that the second derivative of the shift in rates is alive and kicking. Back in 2018, Pimco found a duration of almost 30.

Gold has been on an upward tear this year, having surged 35% in response to a 120-basis point slump in real interest rates. Other catalysts include low global yields; erosion of confidence in global fiat money in general, and a weaker U.S. dollar in particular; unbridled global monetary and fiscal stimulus by Central Banks; and investor purchases through exchange-traded funds in response to uncertainty about the evolution of the pandemic.

However, the outlook for gold gets murky once it goes to around $2,500 an ounce. Beyond that level, it would imply a massive plunge in real rates even more than what we have already seen.

Correlations suggest these factors would also imply a big decline in nominal 10-year treasury yields, which currently sit near 0.50%. Such a move would essentially mean the markets are pricing in a depression-like scenario. Should it play out, the study indicates gold will likely be propelled toward $3,000 should real yields slump to -3.15%.

Given that gold has a longer duration than linkers, the metal offers a balance sheet-economical way to hedge against inflation.

Conclusion

We believe that the US is going to have real rates south of -3% and the time period it is analogous to is the 1940s when real rates averaged -3.14%. On this basis, we believe that gold may reach levels of $3000 and go even higher if real rates go below -4%.

Authored by Ritesh Jain via WorldOutOfWhack.com,