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Gold, Bond Yields and Inflation

gold bond yield relationship inflation real interest rates

Gold, Bond Yields and Inflation

Are you looking to invest in gold, but are unsure what the relationship between gold, bond yields, inflation and real interest rates means? Often gold is spoken of as a “safe haven” investment in that it is a store of value. What does this mean though?

Today, let’s break down the relationships between gold, inflation, bond yields and real interest rates.

Investing in Gold

You can invest in gold in a few ways. First is physical gold, where you purchase and store the metal yourself or have a company warehouse it for you. This way, you actually own the precious metal yourself to sell when prices (hopefully) rise. Other ways to invest in gold could be through ETFs (like SPDR), or through gold mining companies. Miners usually fall into Junior or Senior producers, with Juniors focused on exploration and development and seniors focused on acquisitions. Precious metals miner stocks can be sensitive to the price of gold in that it will directly affect their bottom line. Most will operate based on an all-in cost of production per ounce (say $1200/oz), hopefully reaping huge profits when the market price of gold exceeds this profitability measure.

Why does gold hold value? Isn’t it useless?

Some people argue gold is useless, or that it is obsolete as an asset class. While it does have some commercial and industrial uses (jewellery, electronics, etc.), it is still mostly used by governments and investors as a safe-haven asset in times of market volatility.

A timeless point of view for gold however, is that it is a “true” form of currency or money; it has been valuable in all cultures for thousands of years – and it is a physical thing you can actually own (as opposed to Bitcoin). As a physical commodity, it cannot just be printed or created, like paper money.

Gold is priced in US Dollars – whose value fluctuates with inflation

Being a commodity, gold is priced (or measured) in US dollars. This means that as your dollar cheapens (losing value through inflation or other reasons), it effectively buys less gold (much like oil, wheat, coffee, etc.). For instance: $1.00 in the year 2000 would be worth $1.54 today; prices of commodities (whose utility does not change) reflect this weakened measurement.

How Commodities act as a “Store of Value”

Let’s talk about oil for a second. Oil, as a commodity, is traded through futures contracts on the open market (like gold). A barrel of oil is essentially a measure of energy – ie. it produces the same amount of energy regardless of its price in dollars. So its value is measured in a different, finite way. The same could be said for gold, in that it will be valuable in the same way at different points in time and in different places – plus it will never spoil. It could just be held (with storage costs) until the market price is favourable to sell.

Gold and Bond Yield Relationship

Often traders will look at the US 10-year Treasury Bond Yield as the basis of current interest rates and where they’re headed. They are also relatively safe as an investment vehicle because they are backed by the US government.

Say a bond costing $1000 had a 10% yield of interest paid out annually. If interest rates rise to say 12.5%, the cost of the original bond would need to decrease to make it attractive to buyers who could just buy the newer bond at a 12.5% rate. Effectively, as prices of bonds increase, their yields fall, as the market is flooded and there is no need to drop prices. When prices are low, yields rise to become more attractive to buyers.

Interest, Inflation and Real Interest Rates

OK – so lets say interest rates on US 10-year bonds are 1.5%. Sounds like a really safe way to see a return on investment – especially for large institutional funds and people who want a safe, steady portfolio. But if inflation is at 2% (i.e the value of your money decreases by 2% year over year), then the real interest rate would be the current interest rate – inflation. In this case, you would actually be losing -0.5% on your money each year. Ouch.

Gold as an Inflation Hedge when Interest rates are low

When real interest rates become negative, gold really shines. Rather than losing money over time to inflation (even while you’re supposedly gaining interest), you can store that value in a commodity measured in dollars. Because it is measured in dollars, but also based on its value as a useful physical material, its price can rise and fall based on the strength or weakness of the currency in which it is measured.

Gold, Bond Yields and Inflation

Always do your due diligence when investigating any investment. Many professionals recommend at least 5% of your portfolio be in gold, be it physical, ETF or through gold miner stocks.

There is one key takeaway I have found through investing in gold that I would like to share. Gold is often thought of as a contrarian investment, because you are effectively betting against the economy. Obviously governments can go crazy with spending, and on paper (at times) it can seem like we are headed towards fiscal disaster the world-over. In times like this, its hard to see how you could lose with gold. But I would caution any precious metals investor: do you really want to bet all of your chips against the success of world economies – the one thing every government, business, household and individual is striving for?


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