In Case You Missed It

Wed, Feb 1, 2012 - 8:39pm

Lots of interesting stuff going on today. Our precious metals rallied and the open interest numbers continue to contract. However, the biggest story of the day flew under the radar.

You've probably heard it said that "gold performs best in an environment of negative real interest rates". You've probably then asked yourself: "Self, what the heck does that mean?". Well Turd The Answer Man is here to help.

Everyone knows what an interest rate is but what is a real interest rate? Simply put, it is your stated interest or coupon rate minus the rate of inflation. In a simple calculation, it looks like this:

5% (interest rate) - 3% (inflation rate) = 2% real interest rate


3% (interest rate) - 5% (inflation rate) = -2% real interest rate

The real rate should always be the investors primary focus. What good is a 10% bond if inflation is 20%? The only thing you're guaranteeing yourself is a 10% annual loss of purchasing power. That dog won't hunt.

Not coincidentally, managing real rates is the primary reason why the Fed manipulates the gold market through the bullion banks. Soaring gold would be a sure sign of present or future inflation. Expectations of significant inflation lessens investor demand for fixed interest rate securities like treasury bonds. Less demand equals lower prices. Lower prices equal higher rates and higher rates bring down The Great Ponzi. Similarly, managing real rates is also the reason why the Consumer Price Index is constantly being reworked to indicate a lower rate of inflation.

In understanding all of this, now ask yourself: "What is it that all of the AGAs always say is the primary drawback to owning gold?". Is it because it's a barbarous relic? Is it because it costs so much to deliver and safely store? Well, yes, the AGAs do point to these two arguments. However, the main argument that you always seem to hear the most is: GOLD DOESN'T PAY ANY INTEREST. Sure, the price of gold might keep up with inflation but, since it doesn't pay interest or a dividend, the gold holder is only securing for themselves a rate of return that might approximate the rate of inflation. Stated another investors only receive a 0% real interest rate.

So, there's your answer. From the traditionalist's point of view, gold suddenly has real value in an environment of negative real interest rates. Why? Because 0% is always better than -2% or -5%. It's as simple as that.

Now, lets' get back to the story today that might have evaded your attention:

In summary, something called the Treasury Borrowing Advisory Committee (think of it as the primary Primary Dealers) is advising the Treasury Department to begin "allowing for negative yield auction results as soon as practically possible". In English this means: Build a platform whereby treasuries can be sold with a guaranteed negative rate of return. You give the U.S. government $1010 and they'll return to you $1000 at maturity, thank you very much. What a sweet deal! The U.S. government charges the investor 1% for the privilege of holding their money. (I guess we should just be thankful that this facility will be voluntary...for now.)

At any rate, let's go back and do some more real interest rate calculations. Shall we?

-1% (interest rate) - 3% (CPI inflation rate) = -4% real interest rate


-1% (interest rate) - 8% (ShadowStats inflation rate) = -9% real interest rate

So here's the point: As we move into an environment where we are institutionalizing extremely low and even negative interest rates, we are creating a permanent state of negative real rates. And, as the pundits say, "gold performs best in an environment of negative real interest rates".

So, buy the dips! The secular bull market in precious metals continues and will continue indefinitely.

Rock on, Wayne! Party on, Garth!

Waynes World-Bohemian Rhapsody


About the Author

tfmetalsreport [at] gmail [dot] com ()

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Key Economic Events Week of 6/21

6/21 9:45 ET Goons Bullard and Kaplan
6/22 2:00 ET CGP on Capitol Hill
6/23 9:45 ET Markit flash PMIs for June
6/24 9:30 ET Durable Goods
6/24 9:30 ET Q1 GDP final guess
6/24 9:30 ET Goons Bostic and Harker
6/24 11:00 ET Goon Williams
6/24 1:00 ET Goon Bullard again
6/25 8:30 ET Personal Inc and Spending
6/25 8:30 ET Core PCE
6/25 10:00 ET UMich Consumer Sentiment

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