As gold has plunged in the past couple months, yields on benchmark US 10-year Treasury Notes have soared. Many Wall Street analysts claim these rising long rates are very bearish for gold, and have exacerbated its recent weakness. Since the metal yields nothing, higher bond yields make investing in gold less attractive. This thesis certainly sounds logical, but do rising long rates really threaten gold?
Like any market theory, this one is best tested against the record of history and precedent. If rising or higher bond yields hammered gold prices in the past, then the gold bears’ warnings about their impact this time around are probably justified. And given the extraordinary surge in 10y Treasury yields in the past couple months, gold investors really need to consider how these yields affected gold historically.
Submitted by Adam Hamilton, Zeal
Between early May and late June, 10y Treasury yields skyrocketed 56% higher from 1.66% to 2.59%! That is the biggest increase in this benchmark yield in such a short span in at least a half century, if not ever. Nothing even remotely close to this has ever been witnessed before per the Federal Reserve’s own data, which stretches all the way back to early 1962. We are in uncharted territory for long-rate surges.
And the Fed itself is the sole reason why 10y Treasury yields are soaring. Its latest debt-monetization campaign of pure inflation is widely known as Quantitative Easing 3. The $45b-per-month Treasury-buying portion of this was launched at the Federal Open Market Committee’s December meeting. Ever since, the Fed has been the biggest and dominant buyer of US Treasuries. No one else comes close.
The Fed literally creates brand-new fiat dollars out of thin air to purchase these Treasuries, which is pure inflation. All this artificial demand has naturally boosted the prices of Treasury bonds, and of course yields move inverse to bond prices. So when fears began emerging of the Fed’s massive QE3 buying starting to wind down, bond investors wisely dumped Treasuries ahead of the Fed’s price-collapsing exit.
The widespread belief that rising or higher Treasury yields are bearish for gold extends back to the early 1980s. After a popular-mania-driven parabolic explosion higher in late 1979, the last secular gold bull climaxed in January 1980. The day gold topped, 10y Treasury yields were running 11.0%! And they were heading higher still, reaching an unthinkable 15.8% in September 1981. Gold prices just collapsed.
But that doesn’t tell the whole story, correlation doesn’t necessarily imply causation. After soaring 182.6% higher in just 5 months leading into that parabolic climax, gold was due for a brutal bear no matter what long rates did. Provocatively between August 1976 and January 1980 when gold rocketed 731.7% higher, 10y Treasury yields relentlessly climbed 42.2% from 7.7% to 11.0%. Gold still exploded higher.
Despite the popular misconception, long rates are not always highly correlated with gold. And this too makes sense. Gold has never paid a yield, yet it has remained a popular investment for millennia. The investors buying gold are not looking for yields from that portion of their portfolio. They want proven protection from monetary inflation, financial insurance for unforeseen market events, and most of all capital gains.
The gold-has-no-yield-therefore-it-cannot-be-valued thesis is perpetually popular among gold bears, but it is a flimsy red-herring argument. While bond investors indeed buy bonds largely for yields, that has never been the case with most stock investors. Though there are elite blue-chip companies with high dividend yields, they are a tiny exception to the norm. The vast majority of stocks never pay any material dividends.
Investors happily buy technology stocks even though very few pay dividends. And the ones that do offer dividends almost always have trivial yields relative to their stock prices. Capital gains are the dominant reason investors invest outside of the bond world, and even inside it among professionals. Yields are nice, but certainly not necessary to stoke investment demand. Investors simply want to buy things that go up.
That is why gold has thrived many times in rising-yield environments. Like everything else, the gold price rises and falls based on supply and demand. And investors demand it when they believe it is going to rise, long rates are irrelevant. The vast majority of gold investors are not refugee bond investors looking for income and begrudgingly settling on zero-yielding gold. Those guys stay in bonds and high-dividend stocks.
And the other investors around the world who catapulted gold 638.2% higher between April 2001 and August 2011 didn’t buy this metal because low bond yields left them no choice. This first chart looks at benchmark 10-year Treasury yields and the gold price over the last dozen years of the latter’s secular bull. For nearly its entire bull run, gold thrived in long-yield environments much higher than today’s.
This chart really frustrates me. It would take an experienced Wall Street analyst about a minute to superimpose gold over long Treasury yields, and about 5 minutes to digest the resulting chart. This stuff is child’s play for honest students of the markets. Yet Wall Street analysts refuse to investigate. They keep repeating their tired mantra that rising bond yields hurt gold whether history proves that true or not.
Late last month the benchmark 10y Treasury yields indeed rocketed their fastest ever to 2.6%. And this was indeed much higher than their July 2012 all-time record low just above 1.4%. And yes, after averaging just 1.8% in 2012, 2.5%+ 10y Treasury yields are high relative to recent history. They are already wreaking havoc in other markets, including mortgages which are absolutely critical for US jobs growth.
But the recent super-low Treasury yields are a new phenomenon caused by the Fed’s wildly unprecedented quantitative-easing campaigns. What is now known as QE1 began in late 2008, and the Fed started buying Treasuries in early 2009. This continued through QE2 and now QE3. All this artificial demand drove up Treasury prices, forcing down their yields. Before that nearly the entirety of gold’s secular-bull gains occurred at way-higher yields.
After its stealthy birth in the depths of secular-bear despair in April 2001, gold achieved its first major high over 5 years later in May 2006. Over that 5.1-year span, this metal nearly tripled with a 180.6% gain. And during that time, the average yield in benchmark 10y Treasuries was over 4.4%! If far-higher long rates than recent history indeed discourage investors from buying gold, it never should have rallied in the early 2000s.
During the first 7 years of gold’s secular bull climaxing in March 2008, the metal nearly quadrupled with a 291.7% gain. Yet over that entire span, 10y Treasury yields averaged 4.5%. Gold investment demand was obviously quite independent of bond yields. Gold investors bought gold looking for capital gains in a secular-bull market, while bond investors bought bonds looking for recurring income through yields.
By December 2009 gold’s secular bull had been powering higher for nearly 9 years, and somehow managed to gain 373.5% across a once-in-a-century stock panic over a secular span where the 10y Treasury yield averaged 4.3%. Like everything else in the global financial markets, that epic fear superstorm led to wild gyrations in Treasury-bond prices and yields that ultimately dwarfed 2013’s.
And if Wall Street analysts are correct that rising long rates are bearish for gold, then falling long rates must be bullish for gold right? If yields fall low enough, then bond investors should get so discouraged that they say to hell with bonds and shift their capital into gold. The stock panic’s extreme volatility in 10y Treasuries offers a great laboratory to test this popular bearish notion. History shows it is simply false.
Between October and December 2008 as fear catapulted off the charts, investors flooded into bonds with a vengeance. This crushed 10y Treasury yields down 49% from 4.1% to 2.1% in just a couple months! Now with yields plunging to such dismal all-time record lows at the time, bond investors should have fled into gold per the Wall Street theory. Yet the gold price merely rallied 2.2% over this exceptional span.
And then between December 2008 and June 2009 as the global financial markets stabilized, investors aggressively sold Treasuries which forced the 10y yield up 91% to 4.0% in just under 6 months. Man, with stellar 4% yields available in “risk-free” US government debt who on earth would want to own gold? It yields nothing, zero, zilch, so it must be worthless. Yet the metal rallied 11.6% over this big and fast yield-spike span!
Gold continued way higher after that as the Fed’s highly-inflationary Treasury buying artificially forced bond yields lower. But over the entire 10.4-year span of gold’s secular bull to its latest August 2011 interim high, this metal soared 638.2% higher during a time where benchmark 10y Treasury yields averaged 4.1%. Thus gold’s entire secular bull happened when 10y Treasury yields were 2/3rds higher than today’s!
The Wall Street notion that higher bond yields sap gold investment demand, which I’ve probably heard a hundred times on CNBC in the last couple months, is a red herring. It is an argument that sounds logical on the surface, but is simply untrue. Rising long rates weren’t a threat to gold in its last secular bull, and they weren’t a threat to gold in this secular bull. Another case in point is crystal clear in the chart above.
Between June 2003 and June 2006, 10y Treasury yields soared 68% higher from 3.1% to 5.3%. Surely 5%+ yields would crush gold, right? All those deluded fools buying that anachronistic zero-yielding relic would see the error in their irrational ways and shift into good safe Treasuries. But that’s not what happened. Over that 3-year span, the gold price climbed 63.8% despite a steady rising-long-rate environment!
Wall Street claims rising long rates threaten gold not because it is true, but because they don’t like gold, never have, and don’t understand it. During that 10.4-year span where gold surged 638.2% higher in a mighty secular bull, the beloved flagship S&P 500 stock index fell 1.9%. It was languishing in a secular bear, a massive sideways grind. Despite this vast performance difference, Wall Street never warmed to gold.
They view gold as competing with stock markets rather than complementing them. They see higher gold prices as a barometer of higher inflation and greater uncertainty that will scare investors out of general stocks. And lower stock investment and stock trading means much lower incomes for the entire Wall Street industry. So for gold’s entire run higher, Wall Street either ignored or scoffed at gold’s massive bull.
Bearish theories were always advanced, no matter how far gold ran. But since it has suffered a normal correction that cascaded into a brutal plunge this year driven by a couple key unsustainable and waning anomalous factors I explain in depth in our new July newsletter, there is suddenly a huge market for gold bearishness. And the old gold perma-bears on Wall Street are of course happy to oblige, savaging gold.
Traders crave bearish gold theories today like this thoroughly-disproven bond-yield one because they want to rationalize 2013’s exceptional gold plunge. They want to believe it is fundamentally righteous instead of a short-lived extreme emotional anomaly driven by extreme fear that is already burning itself out. And just like after 2008’s extreme stock panic, a massive rebound upleg in gold is imminent as fear fades.
Rather amusingly, bond yields will likely play a role. But not how you’d expect. In the coming weeks, bond investors are going to get their Q2 financial statements and be shocked to see double-digit losses in their principal invested in supposedly risk-free and safe US Treasury funds. In just one quarter, all their yields earned in the past 4 or 5 years were totally wiped out! They will be dismayed, outraged, and scared.
No doubt some will decide 2%, 3%, or even 4% nominal yields (much lower after true inflation) aren’t worth the growing risks of staying invested in a generational bond bubble while the Federal Reserve contemplates scaling back its unprecedented Treasury buying. Some will likely decide to move some of their bond capital into gold. Sure there’s no yield, but gold is low and due to rise while bonds are high and due to fall.
So the surging long rates could actually increase gold investment demand! You’ll never hear that on CNBC, even though the capital losses in existing bond portfolios driven by rising yields have coincided with huge gold uplegs in the past decade. Interestingly the rates that affect gold most are not the long ones dominating headlines in the past month, but real rates. These are bond yields after inflation.
I wrote my first real rates and gold essay back in July 2001 when the metal traded at $270. I pointed out how bullish negative real rates were for gold, a hugely ridiculed contrarian position back then. My latest essay on this thread was published last November. So if you want to dig deeper, read that. But for today, just take my word for it after over a decade of study that negative real interest rates are very bullish for gold.
This final chart looks at negative real rates and gold. They are not based on 10y Treasury-note yields which require capital to be tied up for a decade, but 1-year Treasury-bill yields. From these inflation per the year-over-year change in the lowballed Consumer Price Index is subtracted. The result is real interest rates, and they have contributed considerably to the gigantic surge in gold investment demand globally since early 2001.
Forget about 2013’s epically anomalous gold selloff for a second, and look at how gold has fared over the past dozen years with low and negative real rates. In a negative-real-rate environment, bond investors actually lose purchasing power by owning bonds. The yields they earn are below the inflation rate, so they effectively pay for the privilege of lending their own money! Thus negative real rates drive bond investors into gold.
Sure gold has no yield. But it more than keeps pace with inflation over most reasonable timespans, so investors’ capital isn’t shrinking in real terms. And real rates have been overwhelmingly negative since December 2008 when Bernanke’s Fed embarked on its asinine anti-saver anti-economic-growth zero-interest-rate policy. The total failure of ZIRP is what led to the inflationary abomination of quantitative easing.
While the Fed has totally lost control of the long end of the yield curve in the past couple months, it still controls short rates with an iron fist. It directly sets the federal-funds rate, which banks use to lend to each other mostly overnight. And all short yields are keyed off of that. The shorter their maturity, the greater the Fed’s influence. And even out on 1-year Treasury bills, the federal-funds rate still utterly dominates.
In the FOMC’s latest meeting, it said it intends to keep ZIRP in place for “at least as long” as unemployment remains over 6.5% and inflation a year or two out is not expected to exceed 2.5%. Traders rightfully interpret this as meaning years into the future. As long as ZIRP is active, 1y Treasury yields are not going to rise much above current levels. And even lowballed CPI inflation isn’t likely to fall under 1%.
So negative real rates are not dependent on quantitative easing like long rates, but ZIRP. And the Fed is going to hold rates near zero for years to come. It can’t even reduce the pace of its balance-sheet expansion from all the QE debt monetization, let alone even start thinking about raising rates yet. As long as negative real rates persist, investment demand for gold is going to continue to grow on balance. It’s that simple.
So don’t worry about long rates and gold, one of Wall Street’s many anti-gold red-herring arguments. The real story on bonds and gold is real rates. And until the Fed musters the courage to catapult its federal-funds rate from zero to at least 1.5%, negative real rates are going to remain firmly entrenched. And they are wildly bullish for gold as the past dozen years have proven. 2013 was an anomaly that is already passing.
At Zeal we never accept any market argument without first investigating it ourselves. This has led us to a hardcore contrarian worldview. We buy low when others are afraid and sell high when others are brave. Thus we remain super-bullish on gold today despite the epic bearishness pervading it. Just like after 2008’s stock panic, the biggest uplegs ever seen are born out of the most extreme bearish sentiment.
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The bottom line is rising long rates don’t threaten gold. Throughout its secular bull, gold has thrived while 10-year Treasury yields were higher or rising dramatically. Bond investors and gold investors are distinct groups with different goals. Gold investors aren’t looking for yield, they seek capital gains. And global gold investment demand grows for many reasons whether long rates happen to be rising or falling.
You can actually make the case that the severe capital losses in bonds driven by fast-rising yields are bullish for gold. There is no sense parking capital in bonds when they are being sold off aggressively, leaving gold much more attractive. And as long as real interest rates remain negative, which will persist for as long as the Fed holds rates artificially low near zero, gold investment demand will continue growing.
Adam Hamilton, CPA
July 5, 2013
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