Wednesday, February 22, 2017

Real Negative Interest Rates Drive Gold Higher

The Bureau of Labor Statistics delivered the January inflation stats like a bombshell. The U.S. consumer-price index (CPI) hit 0.6% in January.
Source: BLS

That's the fastest pace in four years ... and year-on-year inflation hit 2.5%. That's the biggest gain in five years since March 2012. Frank Holmes had a nice chart on that in Forbes.

Inflation is at 2.5% ... and the 10-year Treasury yield is at 2.4%. That's a negative rate. Meanwhile, the effective Fed Funds rate is much lower, at 0.65%. No matter how you slice it, we are at negative real rates.

And Frank says that negative real rates are a force driving gold higher.

He has a point. So we should ask the question: What is driving inflation? Will those forces continue, and thereby push gold even higher?

One inflation driver is food. The food index rose 0.1% in January, its first increase since April 2016. Housing is playing its part as well. Rent rose 0.3%, and the cost of owning a home rose 0.2%. You'll also see small climbs in clothing and cars.  

But the biggest driver is energy. According to the BLS, the energy index rose 4% in January. That's the fifth increase in a row. And the gasoline index jumped a whopping 7.8%.

So if we can figure out what's happening with energy prices, we should have a clue to what will happen with gold. Here's a chart of West Texas Intermediate, the U.S. oil benchmark.

Chart link

You can see that oil prices have channeled sideways since Mid-December. So, momentum indicators will be useless. However, we can also see prices are tightening up. It's an ascending triangle. A breakout to the upside is likely.

If oil breaks out, inflation should heat up. Real yields will fall even more, even if the Fed raises at a "slow and measured" pace. That should lift gold.

Fundamentally ....

  • Global petroleum inventories are falling but still high. At the end of December, inventories fell to below 3 billion barrels, but were 286 million barrels above the five-year average. That's according to the International Energy Agency..
  • We know that OPEC is mulling extending its production cuts. Those production cuts (approximately 1.8 million barrels per day between OPEC and its allies) are the main force in oil's recent rise. 
  • We know there is a glut of gasoline. That should weigh on prices in the very short term. The gasoline glut is due to weather-related traffic slowdowns. Longer term, Americans are buying more cars, and more gas-guzzling luxury cars.

This all adds up to a potential short-term pullback in energy prices. But the longer term is quite bullish, especially if OPEC extends its production cuts. That's because global demand continues to rise as the global middle class expands and buys more cars. 

So, this started out as a story about interest rates and gold. Now we've gone on to energy. It's all interconnected, as you can see. And this leads us to a big picture that is quite bullish for gold.

Speaking of interconnected, Eurozone inflation also hit a 4-year high in January. That's a part of the world which was in DEFLATION not too long ago. Again, energy prices are the biggest driver.

The point is, gold could see buying pressure on both sides of the Atlantic. And energy prices will be key. 

I'll write about ways to play this trend another time. 


  1. Gold should also go up on safe-haven buying since there's a nutcase in the White House now.

    But it won't cos the left wing historically don't stockpile gold and guns.

    1. The sun doesn't rise and set on Mr. Trump. There is more to the gold market than his actions. That said, I believe he is positive for inflation (so negative for ordinary people's wallets). But we'll see.