Gold at Six Year Inflection Point

It’s make or break time for the shiny metal – since the 2011 high of $1920, gold has dropped -33% and now it’s challenging the six year downtrend.

Gold Monthly Chart Since 2002

The bullish and bearish case for gold centers around interest rates and inflation, or in Wall Street speak  “real interest rates”.  The real interest rate is calculated by subtracting the rate of inflation (CPI) from the interest rate observed on government bonds. For the mathematically challenged there is an easier way – just look at inflation protected Treasuries or TIPs rates.

The following chart illustrates the relationship between gold and real rates.

Gold v 5 Year Real Rate

BK will make the explanation really simple:  if the blue line (real rates) is going down then the red line (gold) should be going up.  This happens because gold costs money to store, so as the real amount of money earned on bonds drops the incentive to hold gold increases.

So what does this mean for our inflection point? And what is the signal coming from the price of gold?

If gold breaks the six year downtrend, then the signal is that bond yields will be lower than inflation.  Either inflation will increase or bond yields will drop…or both.

The fact that the 10 year US Treasury rate just dropped below a key support level makes BK lean toward the falling yield explanation for gold strength.

10 Year US Treasury Yield

For BK’s part he is already long of gold betting that it will break the six year downtrend.  Of course market validation is the only arbiter and BK is hyper-vigilant that the downtrend is respected and gold could reverse course.