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Inflation, Interest Rates And Gold Price

|Includes: AU, BHP, SPDR Gold Trust ETF (GLD), IEF, SPY

There are numerous articles which suggest that Gold is hedge against inflation. Some famous investors have invested some percentage of their wealth in Gold. Retail investors try to mirror their investments and invest in Gold. I have yet to come across any valuation model for Gold. Unlike other assets which generates cash flows (like rent from Real Estate, interest from bonds or dividends from shares), gold does not generate any cash flows. This makes it very difficult to value Gold, but there are numerous theories on why Gold is a good investment.

One of the theories is that as inflation increase price of Gold increase. Various Interest rate theories suggest that Inflation has an impact on the interest rates or vice-versa. As inflation increases, Central Banks increases the discount rate or short term rates to control inflation. There are other reasons for the Central Banks to increase or decrease the interest rates.

There are various theories which suggest that investors invest in US Treasury (symbol of risk free rate) to at least earn some real interest rates (Nominal Interest Rate Less inflation rate). There are bonds issued by US Treasury that specifically pays interest rates that are linked to inflation rates. There is a close relationship between interest rates as implied by the inflation linked bonds and normal bonds. The Treasury bonds reflect the inflation expectations.

Based on various press articles about Gold as inflation hedge and also about the Treasury Bonds reflecting inflation, there should be correlation between the two. There is enough documentation on inflation and interest rates. I thought it will be interesting to publish the correlation between the two and see what the results are.

I am attaching correlation data of US CPI, Inflation expectation, 10 year Treasury Bonds and Gold. The correlations are not very high over 5 year period and they are not consistent between different factors over different periods. One can make their own Judgment whether investment in gold is really a hedge against inflation.

Source: WSJ