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The Secret to Gold Prices: Real Interest Rates

Written By Christian DeHaemer

Posted January 20, 2012

TIPS are Treasury Inflation Protected Securities.

They are financial instruments that are guaranteed to keep up with inflation.

Right now, they are selling at a negative yield.

According to Bloomberg:

“The U.S. sold a record $15 billion in 10-year Treasury Inflation Protected Securities at a negative yield for the first time with investors willing to pay a premium to guard against the threat of rising consumer prices.

The TIPS were auctioned at a so-called high yield of negative 0.046 percent. The last four sales of five- year TIPS were at negative yields.”

Why would a record number of investors pay to lose money?

Could it be they think inflation is coming?

Real Interest Rates

Real interest rates are interest rates minus inflation. Real rates tell you what your return is in terms of buying power. And for U.S. Treasuries, real rates are negative.

The yield you get from a one-year U.S. Treasury bond is 0.00%; a two-year is 0.525%; a three-year is 0.25%; and a ten-year is 2%.

According to the Fed, the rates are going to stay low for a long, long time.

Who here thinks inflation won’t go up more than 2% in ten years? Raise your hand.

Bueller. Bueller…

Right, so we can’t make money on Treasuries.

Winter is Coming: Inflation

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase.

As inflation rises, every dollar you own buys a smaller percentage of a good or service. (See my piece on the Fed destroying the dollar.)

As of yesterday, the Bureau of Labor Statistics reported that inflation as measured by the Consumer Price Index for 2011 was 3.0%.

One might think that 3% wasn’t so bad — and it’s not.

That said, the way the government measures inflation has changed over time.

They would tell you that the new method now reflects the fact that the iPhone 4S costs the same as the iPhone 4, but is more valuable.

But the real reason is that politicians don’t have enough money for entitlements, and the electorate won’t vote for candidates who tell them the truth: The lower the official inflation rate of inflation, the lower the cost of living increases that are built into programs like Social Security.

Old-School Realities

If you go by and use the pre-1990 official methodology for computing the CPI, inflation is running just over 6%.

If you use the pre-1980 methodology that was in fashion when Paul Volcker was Chairman of the Fed, inflation is now over 10%.

cpi jan 20

Gold Goes Up on Negative Rates

There is only one historically empirical reason to invest in gold and expect a return.

History tells us that gold is inversely correlated to real interest rates: Gold goes up when real interest rates are negative.

Take a look at this chart (the blue is real interest rates, the gold is gold):

real rates jan 20

And according to the smart money buying TIPS at a negative yield, real interest rates should continue to remain in a downtrend.

Pay Me, Baby: TIPS Yieldtips jan 20Gold is now down to $1,651 an ounce because the dollar bounced.

If you want a TIPS ETF, Pimco’s one- to five- year U.S. TIPS (STPZ) returned 7.70% last year, though you might be late to the party.

All the best,

Christian DeHaemer Signature

Christian DeHaemer

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Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.

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