I discussed gold and whether it was time to buy it in this week’s Weekly Market Update video on YouTube.
Honestly, I have not been as successful in buying junior gold mining stocks as in other resource stocks. That may be more company-specific than my process for determining when I think gold will go on a bull run.
Let’s review the indicators I use to determine if the gold price will rally or decline.
I have found that the primary driver of gold prices is real interest rates. What are real interest rates? Let’s go to Investopedia for the definition.
A real interest rate is an interest rate that has been adjusted to remove the effects of inflation. Once adjusted, it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor.
A real interest rate reflects the rate of time preference for current goods over future goods. For an investment, a real interest rate is calculated as the difference between the nominal interest rate and the inflation rate:
Real interest rate = nominal interest rate – rate of inflation (expected or actual).
This makes sense because recall that gold pays no dividends or interest while you hold it. For example, assume the interest rate you receive on a T-Bill is 3% and assume the inflation rate is 2%. You will have a positive rate of return of 1%. Gold will not perform well in this scenario because you beat inflation by one percent in a risk-free asset (the T-Bill).
For illustration purposes, let’s now assume that the same T-Bill is still earning 3% and the inflation rate is 4%. That is a negative one percent return. You are losing purchasing power relative to inflation.
This relationship between gold and real interest rates can be seen in the twenty-year chart I have included below.
 |
Note that the real interest rate chart in black is inverted. The other thing to note is that gold begins to move higher when real interest rates inflect and begin moving in the negative direction.
When rates are negative or are moving from a positive to a negative direction, the gold price typically moves higher.
What is extremely interesting in the chart is the fact that real rates moved to a highly positive level (relative to recent history). Notwithstanding the last several weeks, the gold price has not pulled back too much.
This likely means that there is some underlying strength in the gold price. If real rates reverse and move higher, we may see a tremendous rally in the gold price and stocks.
I suspect we are near the end of the current rate-raising cycle so it is time to pay attention to gold and gold stocks. I am not ready to buy next week, but we are getting close, in my opinion.
Get your buy list ready; I am.