Just turn on the radio to a talk station and within a short period of time you will likely hear why you need to add gold to your investment portfolio. The representation is that gold is a great investment, a hedge against inflation and will protect you from a declining value of the U.S. dollar and rising interest rates. Since I believe interest rates will indeed rise, several readers of the blog have commented why they believe gold is so important in your investment strategy.
Gold prices peaked in September 2011 at $1,771.88 per ounce (average for the month) and have fallen 36 percent since then.
Let’s take a look at the relationship between interest rates (the 10-year constant maturity Treasury Note) and gold. The following graph shows gold prices and the 10-year Treasury monthly since 1980. Just a visual assessment leads me to the idea that there is a disconnect between gold and interest rates.
The Pearson Product Moment Correlation Coefficient is -0.56329 indicating an inverse relationship (though not necessarily strong) between gold and interest rates. That means that as interest rates rise, gold prices decline and vice versa, at least on average since 1980. This finding is contrary to the null hypothesis that gold prices would rise as interest rates rise (a positive correlation).
Are gold prices a good indicator of future changes in interest rates? To check this, the correlation was calculated on the current gold price and the change in interest rates a year out. The expectation would be a positive correlation between the price of gold today and the change in interest rates a year from now. The following chart shows gold prices and the change in the 10-year Treasury rate a year out expressed in basis points. The Pearson Product Moment Correlation Coefficient between these two factors is 0.08361 which indicates there is no relationship at all between current gold price and the change in 10-year Treasury rate a year out. Therefore, gold prices are not a good indicator of future interest rates.
Next time you hear the radio advertisement for buying gold, just remember that gold is not a good indicator of future interest rates.
My expectation is for gold to fall even further and would not be surprised at $1,000 an ounce or less a year out.
Ted