Notes on My Gold Model

By far the most-viewed post I’ve ever done was my post on a possible model for the price of gold.

The model is based on the idea that gold follows an inverse relationship with real (meaning after inflation) interest rates.

Here’s a look:

In this chart, the gold line is the change in gold prices over the last year. The blue line is the three-month Treasury yield minus inflation. These two lines seem to move in the opposite direction.

My model states that whenever real short-term interest rates are below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. For every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate.

When I first developed this idea, I was really aiming for a model to create a model for the price of gold. I think an accurate model needs to incorporate two ideas — a breakeven interest rate and a volatility ratio. In my original model this was 2% and a ratio of eight.

I believe those are useful long-term averages but I don’t believe those hold up well in the short-term. These aren’t constants. Gold has not done terribly well recently despite real interest rates being negative. I suspect that the breakeven rate has fallen from 2% and now may be close to 0%.

Think of the breakeven rate as the global price to employ capital. The problems in Europe and the slowdown in China may have pushed the rate downward.

Posted by on September 19th, 2012 at 3:34 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.