Inflation has never been the primary driver of the gold sector on its own. Given that gold, as is well known, does not pay interest, the real interest rates equal the opportunity costs. During the 20 years of the gold bear market in the 1980s and 1990s, real interest rates were about 4%. They were negative in only 6.7% of the months. The situation was completely different in the 1970s. Real interest rates were negative in 54% of the months. Since 2000 real interest rates have been negative in 47% of the months, which constitutes an optimal environment for gold.
Real interest rates vs. gold price since 1970
Sources: Erste Group Research, Datastream
When we break down the real interest rates (in this case 10Y yields minus CPI according to Shadowstats) into quintiles and analyse the performance of gold in the subsequent year, we find that there is a clear link between real interest rates and the development of the gold price. In the first quintile (annual real interest rates < -4.3%) gold increases by 21%. With the real interest rates between -4.3% and -1.7%, gold tends to gain close to 20%. It is only when real interest rates rise above 0.99% that the performance of gold weakens significantly.
Real interest rates vs. subsequent gold price performance 1970-2010
Sources: Erste Group Research, Shadowstats
Negative real interest rates reduce interest expense by default and eat into the existing debt. They therefore constitute a transfer from the savers to the debtors. The following chart illustrates the fact that this form of financial repression seems to be in vogue among the majority of nations these days.
Real interest rates worldwide
Sources: Datastream, Bloomberg, Erste Group Research
“Throughout history, feckless governments have dodged their fiscal responsibility by turning to their monetary authority to devalue the currency, monetize debt and inflate their way out of structural deficits“ Richard Fisher, President of the Federal Reserve Dallas, March 2011
By. Ronald Stoeferle of Erste Group
Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.