Low real rates to power next gold rally

Gold leads markets when real interest rates are low

In separate articles, ABC Bullion have presented historical analysis which demonstrates why the potential for more interest rate hikes in coming months not only shouldn’t scare off, but instead should potentially be seen as an opportunity for precious metal investors, given many of the best bull markets for gold have occurred while interest rates are rising.
 
We’ve also looked at why gold tends to perform well when inflation is high (something that is highly relevant considering the consumer price rises we’ve seen across the developed world in 2022), yet still hold its own in periods inflationary pressures dissipate.
 
In this article, we blend interest rates and inflation together, looking at how gold has historically performed in various real interest rate environments.

What do we mean by real interest rates?

Real interest rates are calculated by subtracting inflation rates from the nominal interest rates, with the interest rate used typically either one set by the market (for example short-term deposit rates), or a rate set by a countries central bank.
 
In simple terms, this calculation allows investors to work out what the real rate of return they can earn from simply parking money in the bank is. Inflation is obviously a critical component of that calculation.
 
In Australia, real interest rates sat at -5.25% at the end of June 2022, based on an official inflation rate of 6.1%, and official interest rates (or cash rate target as the Reserve Bank of Australia calls it) of 0.85%.

Gold loves low real rate environments

At ABC Bullion, we’ve analysed more than 50 years, worth of market data, from the start of the 1970s to the end of June 2022.
 
Our research demonstrates that the lower real interest rates are, the better gold has tended to do.
 
This can be seen in the chart below, which shows various real interest rate environments and the average nominal and average real return for gold on a rolling 12-month basis in those time periods.

Chart: Average nominal and real returns for gold in different real interest rate environments 1971 to 2022

Source: ABC Bullion, London Bullion Market Association, RBA, Global Financial Data

The chart highlights that in periods real interest rates are less than 0% (i.e. cash in the bank is going backwards after you factor in inflation) the average nominal return on gold is 26% on a 12-month basis. The return is 18% in real terms, as obviously gold’s returns in real terms also needs to factor inflation in.
 
The real return on gold has historically been 9% or higher in monetary environments where real interest rates are 5% or lower, which they have been for the vast majority of the last fifty plus years.
 
Indeed, based on this analysis, gold has only ever historically delivered negative real returns when real interest rates were 5% or higher. There is very little chance we’ll see such an environment in the foreseeable future, given the headwinds facing the global economy and financial markets.

Table: Real returns on various asset classes in different monetary environments 1971 to 2022

Source: ABC Bullion, London Bullion Market Association, RBA, Global Financial Data

Gold has been the market leader in many of these environments, especially when real rates are 3% or lower. The performance gap is particularly pronounced relative to cash and fixed income assets in those low real rate environments.
 
As per our earlier statements, its only when real rates are 5% or higher (an environment that has only existed in 21% of the time period studied), that gold has historically lagged, both in absolute terms, and relative to other assets.

Takeaway for investors

That gold would do so well when real interest rates are low should be no surprise.
 
After all, low to negative real interest rates mean there is little or sometimes no opportunity cost  in holding gold, as money in the bank is doing nothing for investors in such environments, vs. an environment where real interest rates are high.
 
All other things being equal, that reduced opportunity cost makes gold a more compelling investment in low real interest rate periods. The fact it has historically flourished in such environments only further encourages investors to add it to their portfolio.
 
Secondly, it needs to be remembered that low real interest rates are either a result of policymakers wanting to stimulate a fragile economy, of inflation rates that are getting uncomfortably high, or a combination of both.
 
These environments are often dangerous for shares and other more traditional growth assets. Given gold’s status as a premiere safe haven asset, it is again only natural investors would turn to it as a means of preserving wealth through these periods.

Warm regards,

The ABC Bullion Team

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