Wednesday July 31, 2013 7:00 AM
(Kitco News) - Rising U.S. real interest rates are only one factor that influences the gold market, especially as the yellow metal plays a bigger role in emerging markets, said the World Gold Council on Wednesday.
With the Federal Reserve expected to taper its bond purchases and move away from its extraordinary monetary policy, U.S. Treasury yields have begun to creep up. The common wisdom is that if real interest rates in the U.S. start to rise, it makes the opportunity cost to hold gold greater because gold has no yield. But a new research paper published Wednesday by the WGC, which is the industry-backed group that promotes gold, said that higher U.S. real interest rates aren't an automatic weight on gold prices .
Juan Carlos Artigas, investment research manager at the WGC, told Kitco News in an interview that gold has more global footprint now and is less dependent on economic factors in the West.
"Real rates around the world will not necessarily will follow what U.S. and the EU are doing. The dynamics and economic cycle in other parts of the world may be different by the time the real rates in the U.S. are rising, whenever that happens…. What we've seen in previous periods, for example in 2005-2006, real rates (went) up in the U.S., but other dynamics in emerging markets such as greater economic growth and higher income were further supports to gold demand," he said.
The big argument against gold during rising rates is that the metal has no yield, so the opportunity cost to hold gold rises, too. "But that's true of many assets," Artigas said. "As interest rates increase, the opportunity cost of holding equities or…real estate starts to increase as well because you are incentivized to put your money in the bank."
Gold may have no yield, but that doesn't mean it has no return. Sometimes gold is given a zero percent long-term return estimate when the metal is used to show its role as a core portfolio asset. But the WGC's research shows that gold's average monthly return since 1975 is 0.6%, or an annualized 7.5% nominal return.
Gold performs best when there's a low real interest rate environment, defined by WGC as less than zero percent, with monthly returns averaging 1.5%. But during moderate real interest rates, when the inflation-adjusted rate is between zero and 4%, gold's monthly rate of return is 0.7%. That's largely in line with the long-term average, the group said. When real rates are high, that is over 4%, then monthly average returns are minus 1%, they added.
WGC also noted that in rising real interest rate environments, gold has an average return of 0.3% versus 0.8% during falling rate environments. "While the low returns for the rising environment may not thrill those who opportunistically hold gold for capital gains, they do, however, support gold's portfolio attributes (for risk management). Indeed, the bulk of lower returns come from high and rising rate environments. For example, the period between October 2003 and October 2006 saw U.S. real rates rise from low levels - negative 1% to almost 3% - yet gold had a cumulative return close to 60% over the period," they said in the report.
Many investors point to gold's fall from the 1980s to 2001 and the recent bull market in gold as the proof that gold and U.S. real interest rates are linked. WGC said looking at a chart overlaying inflation-adjusted gold prices and real rates suggests a correlation, but they note the two time periods had several differences. Inflation was much higher in the 1970s than in the 2000s, the U.S. dollar action was mixed in the 1970s but has fallen in the past decade, and now emerging markets are a key part of gold demand and mine supply is evenly distributed globally.
"While it is true that a high real rate environment has not been friendly to gold on average, the underlying data is mixed and obscured by movements in other driving factors, such as the U.S. dollar. We do not know what a high real rate environment would mean for gold, as it would be contingent on so many other factors, not least of which are those that now originate in emerging markets. It is this last facet of the gold market that lends credence to the idea that the influence of the U.S. real rate on gold has receded over the last couple of decades," the report said.
Currency analysts have said they expect the U.S. dollar's trend to start rising when the Fed starts to normalize monetary policy, and a stronger dollar can hurt gold prices because the metal is dollar-denominated.
Artigas said when considering the dollar's role, it's important to think about two factors. One is the dollar versus other currencies and the purchasing power of the dollar. The dollar may rise against developed-market currencies like the euro, but it may fall versus emerging-market currencies. Second, he said, is that the dollar's purchasing power has fallen over the decades.
"When you look at purchasing power…we've seen the dollar depreciating in real terms for the past 40 years. This is something that happens little by little. In the short term, you might see the dollar strengthen, but in long term the large fiscal deficit, the bigger balance sheet of the Fed which was done to reinvigorate (the U.S. economy), that will have a toll on the dollar strength going forward. In the medium to long term, we may see an environment where many emerging-market currencies and some of the developed market currencies start to play a more important role," he said.
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By Debbie Carlson of Kitco News; firstname.lastname@example.org,
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