There's Gold in Them Thar ... Interest Rate Indicators?

Monday, March 12, 2018

Editor's noteMike Larson had some very interesting thoughts about gold, and how the recent extreme moves in interest rates could impact the yellow metal. So, I’ve asked him to take my slot today and share his unique insights.

Enjoy! — Martin

I'm not going to lie. Sometimes I get jealous of the work my colleague Sean Brodrick gets to do.

Cavorting around the mountains of Mexico to research silver deposits. Traveling deep underground in Canada to see uranium mines firsthand. Trudging through the snow and ice to dig up the goods on diamond producers. He's like a modern-day Indiana Jones!

Me? My specialty is interest rates. That means I spend a lot of time working behind a desk or a Bloomberg terminal, rather than heading deep underground.

But while it may not sound as glamorous, my work is every bit as important from an investment standpoint. That's because interest rates can have a HUGE impact on the price of everything … from gold to silver to copper and crude oil.

They can also tell you a lot about whether it's a good (or bad) time to invest in precious metals. In fact, by the time I'm done with today's brief interest-rate lesson, I think you'll be ready to shout: "There's gold in them thar interest rate indicators!"

Let's start with something called the five-year forward breakeven inflation rate. It's one of the Federal Reserve's favorite market-based indicators of future inflation expectations. When it goes higher, it signals that bond investors are increasingly worried about inflation. When it goes lower, it means they're calming down.

Notice anything in the chart below, which goes back a decade? Like how this breakeven rate bottomed at the beginning of 2016, and has been climbing ever since? That's the bond market's way of saying: "Houston, we have an inflation problem!"

Of course, it's not just that indicator signaling trouble ahead. Check out another one I follow called the 10-year TIPS spread. It's the spread, or difference, between the yield on nominal 10-year Treasury notes and 10-year Treasury Inflation Protected Securities (TIPS).

When the spread widens, it signals that bond investors are increasingly worried about inflation. When it narrows, it means they're calming down. So, with that in mind, take a look at this chart. The panel you're interested in is the one on the bottom left ...

You can see that the line on this chart is headed higher, too. That means the spread is widening. And that means we have another confirming signal that inflation worries are heating up.

What investment tends to do well in an inflationary environment? I'm sure Sean would tell you it's gold. He'd be right, too!

The yellow metal has already climbed from a low of around $1,130 an ounce back in December 2016 to around $1,330 an ounce this week, in part because of rising inflation fears. Unless the Fed gets really aggressive with rate hikes to get ahead of this inflationary impulse ... and there's no sign it plans to do that ... gold should continue to benefit.

Or as I said before: There's gold in them thar interest rate indicators! Be sure you own some in your own portfolio.

Until next time,
Mike Larson

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