Thursday, April 29, 2010

A Key To Forecasting Gold Prices

In a nutshell, real interest rates. When after-inflation rates are negative, gold goes up and vice-versa. That's what gold analyst John Doody has found.
As John explained, when the real interest rate is negative – when inflation is higher than risk-free interest – "cash loses purchasing power and buys fewer goods than it bought earlier in the year. When that happens, for protection, investors buy gold and drive its price higher."

Now, take another look at the chart [in the article itself]. John explained, "Today's gold bull market and 1970s gold bull market were eras of negative real interest rates. But importantly, for 2010 to date, the real interest rate has been barely negative, as shown by the chart's red-circled area."

With the real interest rate at about 0%, gold isn't moving anywhere. And John pointed out that the Fed rarely raises interest rates as elections approach. So interest rates should stay where they are.

But eventually, John says, "A pickup in the economy will be the key to higher inflation. With the U.S. economy slowly on the mend, we could see inflation. Real interest rates would go negative and gold would rise."

In order for that driver to kick in - once again - inflation has to pick up. I note that Doody's framework explains why gold can keep rising when nominal interest rates are too.

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