Keep Your Eye On The Prize

Gold is trading lower this morning and most media reports attribute the weakness to next week’s Federal Reserve Open Market Committee meeting. At that meeting, as we have heard endlessly, the Fed is scheduled to raise interest rates by a quarter of a point, and rising interest rates are bad for gold.

But are they?  Paul Farrugia of First Macro Capital put together a fairly detailed analysis of the relationship between interest rates and the price of gold in an article published at ValueWalk and came to an interesting conclusion:

“Follow the commodity complex. Commodity cycles, which considers all commodities together, are more predictable over long-term time periods to gold than interest rates.”

We find that an agreeable conclusion. Interest rates are not a completely reliable indicator as to the future direction of the gold price, not at least when taken alone. Commodity prices indeed are the better, more reliable indicator. That said, there is something else we might want to watch – something that will affect both the commodities complex and gold (which is a part of it) and that is the Fed’s interest rate posture in relation to the inflation rate.

Is the Fed working to keep interest rates above or below the inflation rate?

At the moment the Fed is interested in keeping yields below the inflation rate, so as not to kill off any chances of economic recovery and drive wage and salary incomes relatively lower.  Incomes, if you look at any chart, have not kept up with the rest of the economy and that is probably why the inflation rate is stuck where it is. That, more than the unemployment rate, tells the Fed whether or not the American people are doing well or poorly in the contemporary economy – especially as we approach near full-employment.

Gold over the medium to long run responds not just to interest rates and yields or the inflation rate, but the relationship between the two.  It responds most directly, in other words, to the real rate of return on yield assets and that is why we spend so much time on that aspect of the analysis here at USAGOLD.

As we move into Fed week, gold investors should keep their eye on the prize and disregard the clutter and noise likely to be generated by the mainstream media. The prize is the longer-term relationship between yields and the inflation rate, i.e., the real rate of return on gold and the real rate of return on the dollar. In that regard I re-post the following two charts on real rate of return along with the latest gold-commodities’ complex overlay.

Chart[s] of the Day

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