Real interest rates and gold
Gold is used as an investment alternative. Investors think it protects money’s purchasing power. As an investment, gold must compete against other investments available in the market.
Interest rate is a big factor because it determines the attractiveness of those investment alternatives. If the real interest rate, or interest rate adjusted for inflation, goes up, then the demand for those interest-yielding assets increases, demand for gold falls, and vice-versa.
Tracking interest rates
As we look at US real interest rates, we’ll use the three-month Treasury bill rate minus the year-over-year change in the Consumer Price Index (or CPI). The CPI measures the price paid by consumers for a basket of consumer goods and services. We’ve already discussed the CPI component in the previous part of this series.
Increasing US real interest rates
The three-month US real interest rates have just turned slightly positive. The main reason is the falling US inflation. The CPI for January was -0.1% compared to 0.8% for December and 1.3% for November. The real interest rate was 0.1% for January compared to -0.76% for December and -1.29% for November.
Gold prices have an inverse relationship with real interest rates. As a result, rising real interest rates are negative for gold prices and gold-backed ETFs such as the SPDR Gold Trust (GLD).
Rising real interest rates are also negative for companies such as Goldcorp (GG), Barrick Gold Corporation (ABX), Newmont Mining (NEM), Kinross Gold Corporation (KGC), Yamana Gold (AUY), and ETFs such as the VanEck Vectors Gold Miners ETF (GDX). These companies combined contribute 32.7% toward GDX holdings.
In this scenario, investors can look to ETFs that invest in US Treasury bonds such as the iShares Barclays 20+ Year Treasury Bond ETF (TLT).