Gold investors should be encouraged by the announcement made by the Federal Reserve on Wednesday concerning the direction in which they will take U.S. monetary policy in 2013, i.e. more of the same. The statement, released after a two day meeting, revealed that the Fed has no plans on reigning in its loose monetary policy anytime soon.
What Does The Fed Plan To Do?
A change of tack is definitely not in the foreseeable future. The Fed reported that it will continue buying mortgage-backed securities and longer-term Treasury securities to the tune of $85 billion a month. This, the Fed declares, will help keep interest rates down, provide support for mortgage markets, and make financial conditions more accommodating overall.
According to the report, the Federal Open Market Committee (FOMC) “expects that a highly accommodative stance [italics mine] of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.” In other words, even after the purchase program gets the economy back on track (which lone dissenter Esther George doesn’t think will happen) and lowers the unemployment rate, the Fed will still continue to take an “accommodative” (loose) approach towards monetary policy.
This means that interest rates will be low for the foreseeable future, which doesn’t—in and of itself—entail that the gold price will respond by rising. However, if George, President of the Federal Reserve Bank of Kansas City, is correct, the Fed’s actions will surge inflation, rather than keep it under their goal of 2 percent.
“A prolonged period of zero interest rates may substantially increase the risks of future financial imbalances and hamper attainment [of the Fed’s goal of keeping inflation below 2%],” she said in a speech in Kansas City, Missouri on January 10th.
Either way, the outlook for gold is optimistic. The question is not Will the gold price rise?, it’s How much will it rise?
Gold and the Real Interest Rate
If you take a look at past relationships between nominal interest rates and gold prices, you’ll find that there isn’t a trend on which to base a steady correlation between the two. Nominal rates were down during the gold bull market of the 1930s, as well as during the first 10 years of the current one. However, during the gold bull market of the 1960s and 70s, nominal interest rates were trending downwards.
But this doesn’t mean you interest rates don’t play an important role in the pricing of gold. Nominal interest rates are called “nominal” for a reason. They exist in name only and do not accurately reflect the purchasing power issuing from an investment, because they have not factored in the effect of inflation. The real interest rate takes into account the influence that inflation has on an investment. For example, if the interest rate on your savings account—the nominal rate—is 3%, but inflation is set at 2%, then you are really earning only 1% a year on your savings. This is the real interest rate.
Now, if you go back and research gold’s activity in conjunction with real interest rates, you will find an interesting correlation. You will find that as real interest rates go down, the demand for gold, and therefore, the price of gold, goes up. This is simply because as real interest rates decline, investors shy away from cash and bonds, for their real returns are diminished. If the rate of inflation is higher than the nominal interest rate, investments like these actually lose money.
Historically, real interest rates below 2% are beneficial to the gold price. It’s no coincidence that years that saw lower gold prices—between 1980 and 2000for example—were years in which real interest rates remained above 2%. Low real interest rates mean high gold prices.
Interest Rates and Inflation in 2013
So, with this knowledge, let’s take a look at the current economic situation. Despite the fact that overwhelming majority of the FOMC believes that sticking with its extremely loose monetary policy will benefit the U.S. economy by curbing inflation, there are experts that believe the Federal Reserve is more swayed by the whims of elected politicians than economic prudence.
Allan Meltzer, economist, author and professor at Carnegie Mellon University, sides with George on the topic of the Fed’s latest announcement that it will not change its accommodating ways in 2013.
“President George realizes that the policy is wrong,” he said, “unlike the throng cheering the policy on.” Meltzer believes that the majority of the FOMC is in error to think that prolonging the economic stimulus will keep inflation down and not ultimately vitiate the struggling U.S. economy.
According to the World Bank, the U.S. real interest rate dropped below 2% in 2010, and 2011 saw it go down to 1%. We are currently in a period of negative real interest rates and can expect them to stay negative at least until 2015, if not beyond then. (U.S. Consensus Forecasts predict negative real interest rates for the next 10 years.) If George and Meltzer are correct, we could soon see inflation surge which would cause the real interest rate to plummet even further. Although this is bad news for other asset classes, these economic trends are perfect for gold.
A little research into the relationship between real interest rates and the gold price reveals that real interest rates are one of the biggest factors that influence the price of gold. Knowing what the real interest rate will do in the future is the best way to predict whether or not the gold price will rise or fall, and those in control of monetary policy are taking actions that will end up suppressing real interest rate.
This means that now is one of the best times in history to buy gold, and not gold stocks or exchange-traded funds, but real, physical gold. Gold bullion coins and bars are the best way to invest in gold, as they are extremely liquid and their value is set to skyrocket within the coming years.
Here at Certified Gold Exchange, we have over 20 years of experience advising household investors on the most financially savvy gold investments to suit their portfolios. Our analysts stay abreast of market trends, monetary policies, and political action that affects the gold market in order to pass this valuable information along to our clients. It is our belief that the best gold investments are made by informed customers who are in complete control of their investments, which is why we only advise and facilitate gold purchases. We do not manage portfolios or carry discretionary accounts. It’s your money. Although we can provide you with expert market information, you ultimately know the best way to invest it.
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