Bloomberg News: Here's the Real Reason Gold Has Been Rising

June 02, 2020

Article by Peter Coy in Bloomberg News 

Gold has a reputation as a good hedge against inflation, so if gold is rising, it must be that markets are sniffing out inflation, right? Crispin Odey, a European hedge fund manager, even argues that governments may ban private gold ownership if they lose control of inflation in the wake of the Covid-19 pandemic.

But that line of thinking simply doesn’t stand up. Inflation has been dropping as a result of the pandemic, not rising.

Sure, the Federal Reserve is offering lots of low-cost loans, but without demand from borrowers it’s about as effective as pushing on a string. So, no inflation from the Fed, either.

There’s a more straightforward explanation for gold’s recent rise. Gold goes up when interest rates go down. This pair of charts shows the relationship.

If you adjust the price of gold for inflation, you see it falling in the early part of the past decade as the real yield on government bonds rose. (Real means adjusted for inflation.) More recently, the opposite has been happening: The inflation-adjusted price of gold has risen, while the real interest rate on 10-year Treasury notes has fallen.

This relationship makes sense. Gold pays no interest, so it’s unattractive at a time when the real interest paid on bonds is high. In economists’ terms, the opportunity cost of holding gold is high at such times. In contrast, at times such as this, when the yield to be had from Treasuries is actually negative, gold looks pretty good. 

In short, gold isn’t going up because of inflation. It’s going up because the Fed and other central banks are slashing interest rates to fight the opposite risk—deflation caused by the deep Covid-19 recession.

Of course, gold would also do well if inflation surged and the Fed went easy on raising rates as the economy regained steam ....

To read this article in Bloomberg News in full and view the relating chart, click here.

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