Issue 90
An Update on Gold, Real Interest Rates and the Dollar
In an article entitled ‘Has the Gold Market Already Discounted Fed Tightening?’, which appeared in the October 2014 issue of the Alchemist (issue 75), we discussed the relationship of gold with US interest rates and the US dollar. The relationship had been particularly robust, and we felt it could be used to judge whether the plunge in the gold price in 2013 – 2014 had gone too far.
Just to recount, gold opened 2013 with a pm fixing of $1,693.75 and closed the year with a pm fixing of $1,204.50 – posting a nearly $500 decline for the year. This decline was part of a global ‘taper tantrum’, which included a 130-basis point rise in the US 10-year Treasury yield and a 160-basis point rise in the US 10-year TIPS yield (Treasury Inflation Protected Securities). The Fed, however, did not actually raise short-term interest rates in 2013 – it raised rates for the first time since the Great Recession on 16 December 2015!
Employing a model of the gold price based on an inflation-adjusted US 10-year yield and the US dollar index, the Alchemist article concluded that the gold price had plunged in 2013-2014 by more than the 160 basis point rise in the TIPS yield (and the modest rise in the US dollar) warranted. Gold had accordingly quite possibly already discounted several more years of Fed policy tightening, along with any likely further rise in the US dollar.
As it turned out, gold closed 2014 with a pm fixing of $1,206.00, within $2 of its final pm fixing of 2013. To be sure, the gold price did modestly decline further in 2015, averaging $1,160 for the year. The gold price dipped just under $1,050 on 17 December 2015 however – the day after the Fed hiked the Fed Funds-rate for the first time since the Great Recession. But 17 December 2015 proved to be a turning point for gold, with the gold price averaging $1,250 in 2016, $1,257 in 2017 and $1,324 through to May 2018.
This article updates the relationship of the gold price with US interest rates and the US dollar for the period 2014 to the present. The updated relationship is then used, together with some plausible scenarios for US Treasury yields and the US dollar, to estimate two gold price scenarios (a bullish and a bearish) for the coming quarters.
The first two charts (above) compare the gold price with the US dollar and the US 10-year TIPS yields. (These charts are featured regularly in our Gold Monitor report.) Daily data are used, and annual correlations are presented along the top of each chart.
The correlation of gold with the US dollar index is -0.75 for 2018 to date. (The dollar index charted, EFXR0C, includes only the euro, pound and yen. It’s a narrow dollar index – an index that includes the Canadian dollar has a higher correlation for 2018 to date, but not for previous years.)
The correlation of gold with the 10-year TIPS yield is a relatively low -0.40 for 2018 to date – the correlation was extremely high in 2016, however. Gold and the 10-year TIPS yield appear to have parted ways since late 2017.
The next two charts (above) plot the 13-week change in the gold price with the 13-week change in the US dollar index and the 13-week change in the TIPS yield. The correlations are for the whole period 2014 to the present.
The red circle in the second chart also indicates that gold and the TIPS yield parted company in late 2017. We do not know how long this condition will persist, but we expect a strong negative relationship to reassert itself, because theory holds that when real interest rates rise, gold should decline, all else being constant.
We are not the only ones to note that the correlation of gold with the US TIPS yield has declined significantly in recent quarters, by the way. In an analysis entitled ‘Investment Update: Gold tracks the dollar as rates take a back seat’ (World Gold Council, April 2018),the authors note that while annual gold price correlations with the US dollar were highly negative in recent years, as expected, annual gold price correlations with US interest rates (both real and nominal) had recently declined.
The table below summarises correlations between a 13-week change in the gold price and a 13-week change in various US dollar indices and various US short-term and long-term interest rates.
The darker green cells highlight the highly negative correlation of the gold price with the US dollar and with the US TIPS yields. The red cells highlight the significantly lower correlation of changes in US dollar indices with changes in US interest rates. This is of some importance when estimating a regression model for the gold price using both US interest rates and the US dollar. (Note also that the widely followed US dollar index, DXY, has a lower correlation with gold than the other dollar indices.)
We expect a strong negative relationship to reassert itself, because theory holds that when real interest rates rise, gold should decline, all else being constant.
CORRELATION: GOLD WITH US DOLLAR INDICES, NOMINAL US INTEREST RATES, AND INFLATION-ADJUSTED US INTEREST RATES (TIPS) Weekly data from 1/03/2014 to 6/01/2018 - 231 observations
