As I write Friday morning, the markets are blazing higher — a relief rally in full force. Of course, yesterday was a different story … The 10% crash capped a fall from “all-time highs” to “bear market, down 25% and counting” at the fastest pace in history. As you know, the volatility is largely based on the coronavirus; given that we’re unable to predict how wide the virus will spread, we’re also unable to predict how much financial damage it will inflict, and when our world will collectively begin to return to normalcy. So, despite today’s rally, we probably haven’t seen the end of the selling. I hope I’m wrong, but if not, this is why we own gold. As of yesterday’s close, since February 14, the S&P had fallen 19%. Over that same period, gold has climbed 4%. This is the chaos-hedge in action. And there are likely more gold gains to come … Lower interest rates are the safe bet as our global central banks play defense against the impact of the coronavirus. And low rates should act like kerosene on a fire for gold’s price. For more on this, let’s turn to macro investment expert, Eric Fry. Earlier today, Eric released his latest issue of Fry’s Investment Report. In this issue, he profiles gold, and why it’s likely headed higher. Given the importance of this information for all investors — whether Eric’s subscribers or not — I asked Eric if we could include parts of the issue in today’s Digest, and he graciously agreed. So, today, let’s turn it over to Eric to see why gold is headed higher. Let’s enjoy the relief rally today — hoping for the best but preparing for the worst. Jeff Remsburg

 

Gold Turns Negative Rates into a Positive

By Eric Fry

The gold market loves everything most ordinary investors despise. It loves crisis, falling stock markets and negative interest rates.

Guess what? All three of these scourges are roiling the globe’s financial markets. That means most investors aren’t very happy right now … but the gold market is downright giddy.

And I would guess that the gold market will become even more upbeat over the next the next few months, but not because the coronavirus creates a widespread economic crisis, or because share prices continue tumbling around the world.

These two factors might help nudge gold somewhat higher from its current level around $1,600 an ounce. But if gold is to make a move to new all-time highs, negative interest rates will probably provide most of the fuel.

To be sure, the coronavirus panic and stock market rout are joining forces to trigger the gold-buying impulse. Since the day these twin traumas started terrorizing investors three weeks ago, the gold price surged $100+ an ounce to nearly $1,700 (though it fell back with the rest of the market today to around $1,600).

But while these headline-grabbers are certainly contributing to the gold-buying frenzy, the back-page story is the one that could propel the gold price to $2,000 and beyond.

That story is negative interest rates.

Gold loves low interest rates … and it loves negative rates even more!

Today, more than one quarter of the world’s bonds are “paying” a negative yield. These “deadbeat” bonds literally take a little bit of your money away from you every day. Sure, they don’t take much; but the fact that they take anything is absolutely crazy.

Bonds are supposed to pay money to the lender, not take it away. Negative yields have become so pervasive that a whopping $15 trillion worth of bonds are offering them. Even Greece is paying them!

Traditionally, the gold market would gain strength whenever fixed-income assets like bonds and CDs were paying yields that were below the rate of inflation. The logic of this relationship is simple: If bonds can’t match the inflation rate, then gold seems like a better alternative, since the gold price tends to offset inflation over time.

But today’s situation is without precedent.

Not only are trillions of dollars’ worth of fixed-income assets yielding less than the prevailing inflation rate; they are yielding a loss — a negative return. This bizarre condition seems to be nudging capital into the gold market.

The chart below tells the tale.

 

Clearly, this phenomenon is making some meaningful impact on the gold market. Therefore, if the tally of negative-yielding bonds continues to expand, growing numbers of investors could seek refuge in the gold market.

Meanwhile, interest rates here in the U.S. have dropped sharply during the last few weeks, such that real interest rates — I.e. the interest rate minus the inflation rate — are negative along the entire yield curve.

In other words, every Treasury security, from the 3-month T-bill to the 30-year bond, is paying a rate of interest that is less than the inflation rate. That means these securities are paying are negative real interest. In fact, none of these securities are even close to paying a positive real rate.

The 30-year bond offers the highest yield of them all: 1% per year. But that’s still less than half the inflation rate of 2.5%, which means the bond is paying a real rate of negative 1.5%. That’s a record low.

Only three times in the last 40 years has the 30-year yield fallen below the inflation rate … and never has it fallen as far below the inflation rate as it has today.

The only other time the 30-year Treasury bond paid a real interest rate of negative 1% or below was July 2008, when the gold price was hovering around $900 an ounce. Just three years later, the gold price had doubled to more than $1,800.

That’s the power of negative real rates.

When I first urged investors to re-enter the gold market in the fall of 2018, I stated, “The gold market seems to be a coiled spring that is offering a meaningful amount of upside …”

Since then, that coiled spring has sprung, causing the gold price to jump more than 35%, compared to a return of zero from the S&P 500 Index over that timeframe.

But if the history of interest rates is any guide, gold’s impressive run since late 2018 may be the start of an even bigger move. The chart below provides a fascinating glimpse into that history, but a bit of explanation may be necessary to de-mystify this chart.

It shows the hypothetical results from owning gold under two opposing scenarios. The starting date for this theoretical illustration is August 1971.

Under the first scenario, an investor would have purchased gold whenever real interest rates dropped below 1.5%, then sold gold whenever real rates rose above 1.5%. That hypothetical investor would have reaped a profit of nearly $2,000 per ounce of gold, from a starting point of $32 per ounce!

Under the second scenario, an investor would have purchased gold whenever real interest rates rose above 1.5%, then sold gold whenever real rates dropped below 1.5%. That hypothetical investor would have racked up more than $300 in losses for every ounce they purchased over the years.

 

Clearly, low interest rates are better than high ones, at least from the gold market’s perspective.

Today’s record-low real interest rates do not guarantee a soaring gold price, but they certainly improve the odds.

Regards,

Eric Fry