There have been many articles in the financial press about gold. Some warn that a massive bubble is forming with predictions of a major crash, like what happened in 1980, while others say gold is heading much higher from here.
If you take a look at those 1970s prices, you can see one major difference. Compare the one-year Treasury rate to the price of gold.
Interest rates tripled over the late 1970s. At some point, the rates were pushed so high that it was foolish not to take advantage of them. If I had gold back in early 1980, I might have sold some gold myself for the opportunity to earn more than one percent per month in a bank CD. That’s one reason Fed Chairman Volcker raised rates so high back then – to pull money out of assets and back into cash and cash-like securities.
But now we’re in a different rate climate. Based on the latest announcement from the Fed, rates won’t likely rise anytime soon.
Unless there’s a change in Fed policy, we’re going to have low rates well into 2013. That’s why I think gold continues higher – although the ride could easily be a bumpy one.
Watch futures vs. spot
One way of measuring the attractiveness of gold compared to cash or bonds is its value in the future vs. the present. Looking over some past data, I saw that back in December of 1979, gold for delivery a year from then traded at $491 while the spot price was $415 – a difference of $76 per ounce, or around 18%. That reflected the benefit of keeping money in cash, say in a 16% CD, and delaying a gold delivery.
Today it’s a different story. With spot gold at around $1740, gold for delivery a year from now trades at around $1750. That’s only a $10 difference, or about 0.50%.
When you see future gold prices start trading at levels much higher than spot prices, that will reflect an expectation for higher interest rates and could cause a rapid plunge in the price of gold. But I don’t see that happening – not anytime soon anyway.
Disclosure: I am long GLD.