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« Citi Predicts Gold At $3400 In "The Next Two Years", Potential For Move As High As $6000 | Main | Special Offer: Get Your Money Back if Gold Trades Below $1500 in 2012 »
Tuesday
Dec132011

US Real Interest Rates Indicate Gold Slightly Undervalued

In this update, we look at the latest trend emerging in US real rates. US real rates continue to fall and as a result we remain bullish on gold.

We have covered the dynamics of the relationship between gold and U.S. real rates before, but for new readers and those wanting a refresher, here’s an excerpt from a previous article:

Gold investors tend to focus overwhelmingly on the relationship between the US dollar and gold, citing that a lower dollar leads to higher gold prices in US dollars. Whilst this may be generally true, there is another relationship that does not get as much attention as we believe it deserves, and that is the relationship gold has with US real interest rates. For the first few years of this gold bull market, it was sufficient simply to acknowledge the USD down, therefore gold up dynamic, but now things have changed. Over the past couple of years gold has rallied when the greenback has been making gains, as well as when it was weakening, therefore investors must now take note of the inverse relationship between US real interest rates and gold, which has been observed consistently over the last couple of years. 

The basic fundamentals behind this inverse relationship are that when US monetary policy is looser, real rates fall and therefore investors buy gold for a number of reasons. 

Firstly, lower real rates could imply higher inflationary expectations in the future therefore gold is bought as a hedge against this possible inflation. 

Secondly, lower real returns in Treasuries drives investors into risk assets in search of a higher return. This also sends gold higher but it also sends most commodities, risk currencies and equities higher too. 

Thirdly, lower real returns on Treasuries reduce demand of US dollars, causing the dollar to fall and therefore the gold price to rise in US dollars. 

Finally, looser monetary policy implies that the economic situation is not as rosy as many would like to believe, so if the Federal Reserve acts by loosening monetary policy and driving down real interest rates then that send a message that the economy is in a bad place therefore investors buy gold as a safe haven asset. There are probably many more reasons for this relationship, but we have just tried to cover the main ones.”

We believe the above explanation of U.S. real rates is the key tool for predicting gold movements. Our analysis and subsequent forecasts have been proved correct in the past and our current view is this:

In the past few months we have observed further deterioration in 10 year U.S. real rates to their current level of 0%.

To read the full article, please click here.

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