Gyroscopic Investing

Interesting analysis of Gold and Real interest rates:

http://pragcap.com/a-possible-model-for ... ce-of-gold

Fundamentally the argument that gold and real interest rates are correlated is valid by my book. One of the effects of inflation is to make real interest rates go negative. Happened in the 1970s and is happening now. So although inflation is still "low" by the 1970s standards today, it is still producing around -3% a year in real returns on cash at the moment. This is very close to what happened in the 1970s when interest rates were higher, but inflation was higher still.

He is also correct to state that gold is almost like a currency shorting position:

In effect, gold acts like a highly-leveraged short position in U.S. Treasury bills and the breakeven point is 2%

I don't know if 2% is the break even point or not. But clearly there is some psychological barrier where investors decide it's a better idea to hold gold over a currency that is yielding them negative value. Harry Browne used to say that inflation around 5% or so would make gold more active and I think more or less he was right. But perhaps what he really meant is that inflation that is 5% or more usually is starting to see real interest rates go negative. Once that happens, then gold is going to act like a leveraged investment and take off.

I also agree that inflation is a political decision. This is something I talked about in my latest podcast and other places. If the Fed gets serious about making interest rates go positive and ending inflation, gold will fall quickly.

With all the above said, I don't think you can use this model to predict it well. The markets are likely to lead real interest rate changes in pricing of assets. Meaning that I suspect you'll be chasing your tail by relying on charting to tell you when to buy/sell. I still think rebalancing bands are a lot more useful way to work with assets in a portfolio.

Yeah... not a good predictive tool... but a great way to illustrate to someone why you should own gold.  My uncle is absolutely loaded... loaded to the gills with ultra-safe bonds, and is worried that he should sell the $35,000 he owns in gold in a safety deposit box.

This would have been a good way to describe to him why owning that gold (and more) will actually reduce his volatility.

moda0306 wrote: Yeah... not a good predictive tool... but a great way to illustrate to someone why you should own gold.  My uncle is absolutely loaded... loaded to the gills with ultra-safe bonds, and is worried that he should sell the $35,000 he owns in gold in a safety deposit box.

This would have been a good way to describe to him why owning that gold (and more) will actually reduce his volatility.

Just curious: Have you ever told him about the PP?

No... Given the context of the conversation it would have been a little forced... He just asked about gold.  I probably could have fit it in, but at the time it didn't feel right.

moda0306 wrote: Interesting analysis of Gold and Real interest rates:

http://pragcap.com/a-possible-model-for ... ce-of-gold

The "real interest rates-gold" connection was one of the primary reasons I shifted the majority of my assets into the precious metals sector in early 2009 (and out of the PP).  What the author failed to write, however, is the "why" for negative real interest rates.

Whether we like to admit it or not, we are creatures of habit.  Each generation makes similar mistakes as those before them.  That's why secular cycles exist.  Every generation experiences equity euphoria at some point and valuations get way out of line with historical norms.  When the music stops, people want out and move to cash.  On a gold standard, that means asset crashes, bankruptcies and quick liquidations.  In a fiat world, it's possible to devalue the currency (via negative real rates) slowly so that nominal asset values stay high--creating the illusion of prosperity until asset valuations decline in real terms enough to become attractive again.  The 70's were a perfect example.

Negative real interest rates are a political phenomenon and the path of least resistance.  With PE10 at close to historical highs, we're obviously not done with the current secular bear, so I feel very comfortable in precious metals at the moment.  What I would've liked the author to really key in on was the actual "model price" of gold.  I have my targets, but I'm always interested in hearing others opinions.