REAL INTEREST RATES CONTROL GOLD AND SILVER
by the Optimist
June 16, 2005

The investment climate for precious metals gets hot (bullish) or cold (bearish) depending on the relationship between interest rates and the rate of inflation. When interest rates are low and the fires of inflation are burning bright, then gold and silver will be in a strongly bullish mode. Conversely, when the FED raises interest rates sufficiently high to dampen inflation, then gold and silver prices will descend in a bearish mode.

The chart below shows the monthly data since January 1960 for inflation (CPI, year over year) minus interest rates (3 month T Bills). As indicated in This Time It Really Is Different, the neutral point is not when inflation equals interest rates, but is approximately 1.25% less than zero difference. That offset is due to the interest rate that would exist even if inflation could be magically locked at zero. In the chart below, the zero difference level has been moved to 100, and the neutral rate is illustrated by a blue line at 98.75 %. When the difference between inflation and interest rates is higher than the blue line, precious metals chart a bullish path. When the difference between inflation and interest rates is below the blue line, precious metals endure extended bearish corrections.

Through April 2005, inflation is significantly higher than interest rates, and the Optimist is happy to report that the current environment for precious metals is solidly bullish.

© 2005 the Optimist
(AKA Jim Otis, is an author, active investor and retired engineer.)
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