Are these the golden days for gold?

As my colleague Jean Boivin recently


, central banks are pushing the outer limits of monetary policy.
This has had many odd side effects, not the least of which is a
significant portion of sovereign debt today is trading at a
negative yield. If you buy government bonds from Japan today, you’d
have to pay interest. Welcome to a world in which investors pay for
the privilege of lending money. Although central banks have been
the primary architect of this surreal state of affairs, even if
they decide to reverse course, real borrowing costs are likely to
remain low relative to the historic norm. Factors such as
demographics and tepid economic growth are contributing to the
unusually low level of

real interest rates

(i.e. after inflation). All told,

this is a serious problem for yield starved investors

. Ironically, one potential remedy is to take a second look at an
asset class that provides no income: gold. Even more than other
asset classes, making predictions about gold is a dubious exercise.
For starters, investors can barely agree on what gold is:
commodity, currency or “barbaric relic.” Even investors like
myself, who see a legitimate role for gold in a portfolio, need to
admit that gold is extremely difficult to value. There is no cash
flow to discount and, unlike oil or even other precious metals like
silver or platinum, gold has few industrial uses.
Is now the perfect time and place for gold?

That said, some environments have been more kind to gold than
others. As gold pays no interest or dividend, the opportunity cost
of holding the precious metal is a critical driver of returns.
During periods of low or negative real rates, when the opportunity
cost is low, gold has generally performed better than in periods
when real rates are higher. My colleague Heidi Richardson also
mentioned this

in a recent post

. According to Bloomberg data, since 1971, the level of real U.S.
10-year yields has explained roughly 35% of the annual change in
price of gold

. In those years in which real rates were

average (roughly 2.50%), gold rose by an average of 0.50%. However,
in those years when rates were

the historical average, gold rose by an average of 21%. While real
rates have historically had the most significant impact on gold’s
performance, inflation, more particularly the direction of
inflation, has mattered as well. The best years for gold were those
in which real rates were low and inflation was rising. Since 1971
there have been 12 years that fit that description, as Bloomberg
data shows. Gold rose in 11 of those 12 years with an average
return of over 35%. Given slow growth, a cautious Federal Reserve
and the proliferation of negative sovereign yields in Japan and
Europe, U.S. real rates are likely to remain low for the
foreseeable future. At the same time, both core inflation and wages
have been firming while the inflation drag from last year’s strong
dollar and collapse in oil is beginning to fade. This is exactly
the type of environment that has historically been most favorable
to gold.

Russ Koesterich

, CFA, is Head of Asset Allocation for BlackRock’s Global
Allocation Fund and is a regular contributor to


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