Gold Proves No Haven From Zero Interest Rates

The deliberate and concerted effort by the world's central banks to follow the Bank of Japan and the Federal Reserve down the road of zero interest rates cum quantitative easing does raise questions about the ultimate value of fiat money. If everyone's short-term interest rates are going to zero, there is no need to borrow cheap yen or dollars or Swiss francs and swap them into another currency; you can borrow in your own currency for nothing and incur no currency risk, which will suppress currency volatility.

As I noted in August, gold has failed to provide a refuge. Its 12-month return using the Dow Jones-AIG rolling contracts has been -6.5% -- better than just about all stock and risky bond indices but hardly the returns dreamed about by gold bugs.

Declining inflation expectations have been a principal reason for this deficient performance. Gold or any other static asset should rise in nominal price if expected inflation exceeds the cost of carry -- short-term interest rates in this instance.

The net expected inflation measure began to decline in May 2004, marked below with a magenta line, but gold rose as the new wealth of India and the United Arab Emirates was converted into the commodity. It shot higher at the end of August 2007 (the orange line) as the Federal Reserve began its credit-easing policies, and it peaked in March 2008 (the dotted line) during the Bear Stearns rescue. It has been trending irregularly lower ever since -- the price of gold has been hitting a series of lower lows and lower highs. In dollar index-adjusted terms, gold has been flat since February 2008.

Gold Is Tracking Net Inflation, Not the Dollar Raw Data from Bloomberg

In an approach similar to a December column on silver, I took a global index of gold miners and its relative performance to a general global equity index. Mapping the relative performance of gold miners to stocks in general against the price of gold, a stark division emerges in mid-November 2005, marked in red on the chart below -- this is the same time division seen in silver.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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