Why Gold Underperforms When Real Rates Rise
3 Ideas For Today’s Low Inflation Environment (Part 4 of 5)
2. Maintain an allocation to gold, but consider keeping it small.
Low inflation is likely bad news for gold. As inflation drops, investors are less focused on inflation hedges like gold. In addition, lower inflation and stable nominal rates mean that real interest rates are rising, which could hurt gold.
Market Realist – Gold underperforms when real rates rise
The graph above shows how gold (GLD)(IAU) prices have dipped in the last three years. Spot gold is currently ~$1,180 per ounce. This is a dip of 26.5% in the last 36 months. That’s 8.2% compounded annually.
Gold underperforms when real interest rates increase. The real interest rate is nominal interest rate minus the inflation rate. If nominal interest rates rise, gold underperforms, as many alternative investments like bank deposits become attractive. When inflation rates rise, gold is a good hedge, as it’s a good store of value. So gold moves in the opposite direction of real interest rates.
In the longest recent period of high real interest rates, between January 1995 and November 2000, gold prices remained stable. But gold had an unprecedented bull run from the early 2000s to 2011, which saw relatively low real interest rates except for two short spikes.
With inflation remaining low, gold isn’t very attractive. But you need to keep a small portion of it in your portfolio, as it has a very low correlation with most asset classes, so it provides diversification.
However, US equities (SPY)(IVV) may still provide better returns. The economic recovery in the US is gaining steam and could continue to support stocks. The US seems to be the only bright spot among developed markets (EFA) at present.
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