If the 10-year US Treasury yield rises to 5%, gold will fall to $471 an ounce.
And if that yield rises to just 4%, from its current 2.8%, gold will still plunge — to $831.
And if that yield rises to just 4%, from its current 2.8%, gold will still plunge — to $831.
Those
sobering forecasts come from an econometric formula based on the last
decade’s relationship between gold and interest rates. Assuming this
past is prologue, the only way for gold to make it back to its all-time
high above $1,900 an ounce is for the 10-Year Treasury yield to fall to
1%.
To be sure, a comprehensive model of gold’s price needs to
include more than just interest rates. But, according to Claude Erb, who
conducted these statistical analyses, we should not be too quick to
reject his simple “behavioral” model relating gold’s price to the 10-Year Treasury yield.
Erb is a former commodities portfolio manager for Trust Company of the West and the co-author (with Campbell Harvey) of a recent US National Bureau of Economic Research entitled “The Golden Dilemma.”
FICTION/Theory:
Erb says we should not blithely dismiss his simple gold-interest rate
model because it has had impressive explanatory power in recent years.
Consider a statistic known as the r-squared, which reflects the degree
to which fluctuations in one thing predicts or explains changes in
another. The r-squared ranges between 0 and 1, with 1 indicating the
highest degree of predictive power and 0 meaning that there is no
detectable relationship. In the case of the gold-interest rate
correlation over the last decade, the r-squared is a very high 0.78. (
Click here for a summary of his findings. ) Most correlations on Wall
Street don’t come anywhere close to being that high.
FACT:
Imagine using Erb’s model one year ago to forecast where gold would be
trading when the 10-year yield rises to 3%. At the beginning of 2013, of
course, that yield stood at 1.76%, and gold bullion stood at nearly
$1,700. He told me that the model at that time would have predicted
bullion’s price would be $1,196.70 when the 10-year yield hit the 3%
point.
That point was reached on Dec. 26 of last year, and the London Gold Fixing price on that day stood at $1,196.50. Does that counts as hitting the bulls eye ??
Impressive as his simple model has been, however, Erb stresses that he is not recommending that gold traders focus only on interest rates when determining whether they should be in or out of the gold market. Nevertheless, he reminded us, the gold bulls shouldn’t now be claiming that bullion responds to lots of factors besides interest rates. That’s because it was the gold bulls who were quick — so long as interest rates were declining — to claim that the impressive gold-interest rate correlation justified a higher gold price.
As Erb puts it, “if gold traders want to live by the sword, consistency requires them to be ready to die by it as well.”
What
factor or factors does Erb suggest that gold traders focus on? The one
that he and his co-author Campbell Harvey suggested in their NBER study
is the ratio of gold’s price to the level of the consumer price index.
Since that ratio historically has averaged 3.4-to-1, a rule of thumb
could be that gold is overvalued when the ratio is above that level and
undervalued when below.
Currently, the gold-CPI ratio stands at 5.3-to-1, suggesting gold remains quite overvalued.
That in turn suggests that gold’s fair value is just under $800 an ounce !! So, beware!
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