So I woke up a few days ago and saw this WSJ piece.

Yes, world; letting real rates stay negative for so long was probably going to do that.

I thought it would be a good excuse to compose another thought piece. Like the kids say: here goes nothing.

Now we've detailed potential drivers for inflation in the past - with oil ripping towards new highs (Saudi-corruption-purge-driven or not), nominal rates ripping higher, and stocks falling, I was curious to also see gold also down. 

I am a strong believer that gold trades like a currency rather than a commodity. Commodities for the most part trade based on supply and demand. The demand function is usually the result of end-use products that during special situations may be propelled further by speculative fervor.

Oil gets turned into gasoline and put into vehicles, grains, softs, meats get eaten, metals get thrown together to make cool stuff, etc. etc.




The supply function, in many aspects, behaves in accordance with price. Price goes higher, people invest in getting more of that high price "stuff" whatever it may be and vice versa.

Gold is a bit different. Why? Like all commodities, it can store some value. But the key difference here is the fact that global central banks, those crazy economic professor types, deem it as a viable form of storer of value and medium of exchange so much that they accumulate it as reserves.


As a result, gold more than any other precious metal trades like a currency based on the rates of the country that it's denominated in.

So here we are at the focal investigation of the post. Hypothetically, if inflation rises (let's not argue this right now and just assume such is the case), will gold be a good hedge? 

Let's go to the charts first, since I'm lazy.


Yes, yes I know - I didn't get the chance to run the regression on returns vs returns - I have a very finite window to use BBG and the files I build I cannot keep. On top of that, without a BBG API, it takes a horrific amount of time to manually extrapolate the real yield (before the existence of TIPS) by interpolating the CPI.

With my whining in mind, even with an "incorrect" price vs price regression - you can observe the directional relationship between gold and those rates. Also, the relative relationship between the different rate products vs gold should be valid as well (the base effect from the regression of price vs price as a result of the level differences should be somewhat negated as all the rate products are roughly on the same base level).

Spot gold px vs real yield shows the tightest connection here. So we'll focus in on that one for a sec.


From the above, it is evident that gold goes down when real yields go up in a semi-lockstep fashion. (I assume the economic driver here is: holding gold which yields vs holding a currency which in some situations can yield a lot in real terms and in other situations can yield very little or even negative in real terms)

Conclusion 1 - Gold trades rather closely with real yields. Although there are sure to be other factors influencing the gold price, it is roughly over the long term a function of real yields.

Moving along. Assuming the answered found in Conclusion 1. Can gold always be a good hedge for inflation? Or better yet, can real vs nominal yields diverge (widening of breakevens and thus the emergence of "inflation") without real yields actually going up significantly (real yields going up would theoretically put significant downward pressure on gold)

Let's look at some different yield regimes. 


The two main interests that occupy my focus for this experiment. They are the high inflation periods of the 70's and 80's as well as the periods of shock post the dot-com bubble and the GFC.


Now I'm going to add some events to shed some qualitative light on the various worldly happens which caused individual reactions to rates. 

FYI, for those with a short attention span - this will be a very long table. I will highlight in red those times when real rates were likely zero or negative (higher inflation vs fed funds rate) and I will also provide a summary at the bottom.

Disclaimers: 

The inflation prints were averaged out for entire years while the Fed Funds rate is printed on the table only when a change occurs. Basically, this analysis is far from perfect. 

However, assuming that those highlighted periods were times when real rates were either negative or close to zero is probably semi-safe. Besides what's life without the right amount of danger, eh?

Those with the curiosity of a cat and armed with a Bloomberg terminal can hopefully use this as a launch pad for additional analysis.



DateFed Funds Rate Event
Fed Chair Arthur Burns (January 1970 - March 1978)
1971: GDP = 3.3%, Unemployment = 6.0%, Inflation = 3.3% 
Jan4.5% - 4.0%Expansion.
Feb3.5%
Jul5.5%Fed raised rate to fight inflation.
Aug5.75%Wage-price controls.
Nov5.0%Lowered rate to stimulate growth. 
1972: GDP = 5.2%, Unemployment = 5.2%, Inflation = 3.4% 
Mar5.5%Raised rate to combat inflation. Confused markets.
Dec5.75%
1973: GDP = 5.6%, Unemployment = 4.9%, Inflation = 8.7% 
Jan6.0%Raised four times that month.
Feb6.75%Lowered to 6.5%, then raised to 6.75%.
Apr7.25%Raised for next five months.
Aug11.0%OPEC embargo created inflation in October.
1974: GDP = -0.5%, Unemployment = 7.2%, Inflation = 12.3% 
Feb9%
Jul13%Raised from March to mid-July.
Dec8.0%Lowered gradually from July to December.
1975: GDP = -0.2%, Unemployment = 8.2%, Inflation = 6.9%
Jan6.5%Lowered four times in January.
May5.0%Lowered five times in five months.
Sep6.5%Raised from June through September.
1976: GDP = 5.4%, Unemployment = 7.8%%, Inflation = 4.9%
Jan4.75%Lowered from October through January.
Apr5.5%Raised in April and May.
Nov4.75%Lowered from July - November.
1977: GDP = 4.6%, Unemployment = 6.4%, Inflation = 6.7%
Aug6.0%Raised from December through August
Oct6.5%Raised again in September and October.
Fed Chair William Miller (March 1978 - August 1979)
1978: GDP = 5.6%, Unemployment = 6.0%, Inflation = 9.0%
Jan6.75%
Dec10.0%Raised each month from April through December.
Fed Chair Paul Volcker (August 1979 - August, 1987)
1979: GDP = 3.2%, Unemployment = 6.0%, Inflation = 13.3% 
Apr10.25%
Oct15.5%Raised rates 4 points.
Dec12.0%Gradual decline through the month.
1980: GDP = -0.2%, Unemployment = 7.2%, Inflation = 12.5%
Jan14.0%Increased rapidly that month.
Mar20.0%Raised rates in February and March.
Jun8.5%Lowered to 9.5% in May and 8.5% in June. 
Sep12.0%Rates increased to 10.0% in August and 12.0% in September
Dec20.0%Raised steadily until mid-December.
Dec 2918.0%Lowered two points.
1981: GDP = 2.6%, Unemployment = 8.5%, Inflation = 8.9%
Jan20.0%Reagan took office. Volcker raised rates again.
Apr16.0%Lowered 4 points.
May20.0%Raised 4 points.
Dec12%Lowered 8 points.
1982: GDP = -1.9%, Unemployment = 10.8%, Inflation = 3.8%
Apr15.0%Raised 3 points.
Dec8.5%Lowered nine times over nine months.
1983: GDP = 4.6%, Unemployment = 8.3%, Inflation = 3.8%
Aug9.66%Raised from May to August.
Oct9.25%Lowered from August to October
1984: GDP = 7.3%, Unemployment = 7.3%, Inflation = 3.9%
Aug11.75%Raised from March to August.
Dec8.25%Lowered from September to December.
1985: GDP = 4.2%, Unemployment = 7.0%, Inflation = 3.8%
Mar9.0%Raised from February to mid-March.
Dec7.75%Lowered from April to December.
1986: GDP = 3.5%, Unemployment = 6.6%, Inflation = 1.1%
Aug5.66%Lowered from March to August.
Dec6.0%
Fed Chair Alan Greenspan (August 1987 - January 2006)
1987: GDP = 3.5%, Unemployment = 5.7%, Inflation = 4.4%  
Sep7.25%Raised rates from April to September.
Nov6.75%Lowered after October 19 stock market crash.
1988: GDP = 4.2%, Unemployment = 5.3%, Inflation = 4.4%
Feb6.5%Lowered in January and February.
Dec9.75%Raised rates to fight inflation.
1989: GDP = 3.7%, Unemployment = 5.4%, Inflation = 4.6%
Dec8.25%S&L crisis. Fed lowered rates.
1990: GDP = 1.9%, Unemployment = 6.3%, Inflation = 6.1%
Dec7.0%Recession began in July.
1991: GDP = -0.1%, Unemployment = 7.3%, Inflation = 3.1%
Dec4.0%Recession ended in March.
1992: GDP = 3.6%, Unemployment = 7.4%, Inflation = 2.9%
Apr 93.75%Expansion.
Jul 23.25%
Sep 43.0%Clinton took office in 1993. Fed made no changes.
1994: GDP = 4.0%, Unemployment = 5.5%, Inflation = 2.7%
Feb 43.25%
Mar 223.5%
Apr 183.75%
May 174.25%
Aug 164.75%
Nov 155.5%Raised rates.
1995: GDP = 2.7%, Unemployment = 5.6%, Inflation = 2.5%
Feb 16.0%