By Teeka Tiwari, editor, The Palm Beach Letter
In 1875, a Brooks Brothers suit cost about $10. At the same time, gold was around $23.54 per ounce.
So, for a little more than a half-ounce of gold, you’d be able to buy yourself a nice suit.
Today, a Brooks Brothers suit runs about $778. And gold is trading around $1,225 per ounce.
So, for a little more than a half-ounce of gold, you’d still be able to buy yourself a nice suit.
Here’s my point…
In dollar terms, the same suit costs 78 times more than it did in 1876. But in gold terms, the price is roughly the same.
In other words, gold has maintained its buying power. The same amount of gold today (about 0.6 ounces) can purchase nearly the same as it did more than a century ago.
And that’s what gives gold its value. It does a great job of protecting buying power.
But there are times when we see gold not just protecting money… but also making you money.
We’re in one of those times.
Return of the “Magnet Effect”
The single most important driver of gold prices is something called “real returns.”
A “real return” is simply the rate of return you get on a 10-year Treasury after accounting for inflation.
For example, if you have a 10-year bond earning 2% but inflation is 3%, then your “real return” is -1% (2% minus 3%).
In other words, the money you have in bonds is declining in value each year. That means you can buy fewer and fewer goods with your money.
So when real returns are going negative, the buying power of your money declines. Meanwhile, the price of gold goes up.
When “real returns” go negative, people flock to gold to protect their buying power.
I call this phenomenon the “Magnet Effect.” I told you about this effect last year.
Back in late 2016, real returns went positive and clobbered gold. We ended December with paper losses of 30% across our whole gold portfolio.
At the time, I counseled patience. I said inflation would rise, but bond yields wouldn’t rise fast enough to account for it. If that happened, I told you we’d see gold rally.
Since the beginning of the year, that’s exactly what has happened.
Real returns have once again gone negative. And so far, gold is among the best-performing asset classes in 2017.
Today, I am going to make another prediction…
Why the Magnet Effect Is Still in Effect
This year, we will see bond yields and gold prices rise together.
This rarely happens.
Conventional Wall Street wisdom states that bond yields and gold have an inverse relationship. That means if yields are up, gold is usually down.
That relationship changes when you have inflation. As inflation emerges, bond interest rates start to creep up in an attempt to account for the inflation.
Here’s the thing, though… Historically, the rise in bond yields lags behind the rate of rising inflation.
This was true all through the 1970s when bond yields went from 6% to 16%.
Conventional wisdom thought that would be a horrible time to buy gold… And conventional wisdom was wrong.
Gold soared from $35 per ounce to over $800.
That happened because the inflation rate was consistently 2%–4% above interest rates. This pushed real returns into negative territory throughout much of the 1970s (see chart below).
Remember, when real returns go negative, smart investors flock to gold to protect their buying power. This Magnet Effect will happen all over again.
Now, I’m not expecting 16% interest rates. I am expecting inflation to revert to its historical mean of 3.4%. Under that scenario, gold prices will gun much, much higher.
The key takeaway here is to keep watching the inflation rate.
Don’t sweat any short-term volatility in gold prices. Stay focused on the long game, and you’ll make a killing in our gold stocks.
Let the Game Come to You!
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