Who Needs Gold When Real Growth Is Picking Up?

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Includes: BAR, DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDM, GLDW, GLL, GTU, GYEN, IAU, IAUF, IPE, LTPZ, OUNZ, PBTP, PHYS, QGLDX, SCHP, SGOL, STIP, STPZ, TDTF, TDTT, TIP, TIPX, TIPZ, UBG, UGL, UGLD, VTIP
by: Calafia Beach Pundit

Chart #1

I've been posting updates of Chart #1 for at least the past 5 years. It never ceases to amaze me that the prices of two different assets should be so highly correlated. Of course, gold and TIPS do share a few things in common: both offer promises/guarantees of some sort. Gold promises to maintain your purchasing power over time, and TIPS offer you a government-guaranteed real rate of interest. Both, in other words, offer a form of protection against inflation, and both can be considered "safe" ports in an economic and/or financial market storm.

(Note: In the chart, I have used the inverse of the real yield on 5-year TIPS as a proxy for their price. Like any bond, the price of TIPS goes up as their real yield declines, and vice versa.)

For the past year, this chart has been suggesting that gold prices were lagging the decline in TIPS prices. Gold now appears to be "catching up." Awfully tempting to see gold prices move still lower.

Why should these two asset prices tend to correlate so well?

Gold and TIPS prices rose in the late 2000s as the economy crashed. A weaker economy made gold more attractive because many figured that monetary easing in response to significant economic weakness might spark a rise in inflation. And gold is a natural safe place to hide when there is economic and financial market chaos. TIPS rose in price as well, because there was strong demand for the guaranteed real yields that they paid when other asset prices were collapsing.

For the past 5 years, gold and TIPS prices have been irregularly declining, because the market is coming to appreciate that the outlook for economic growth is improving, and that lessens the need for accommodative monetary policy, and that, in turn, lessens the risk of an unexpected rise in inflation. Moreover, the returns on other assets have been very attractive of late, and that weakens demand for gold and TIPS, because neither promises much in the way of return (gold pays nothing, and the real yield on TIPS is meager). Plus, there is just less need these days for the security and safety of either asset. And of course, there is less demand for inflation hedges now that we have seen two decades of inflation averaging 2% or less, and now that the Fed is beginning to reverse its quantitative easing stance.

Chart #2

Chart #2 shows how real yields on TIPS do indeed track changes in economic growth fundamentals. A very strong economy in the late 1990s saw very high real yields on TIPS, whereas the past decade of sub-par economic growth has seen very low real yields. Both growth and real yields have been moving higher in recent years.