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3 Drivers, 2 Months, 1 Gold Rally?

 November 07, 2011 06:51 PM


Federal Reserve Chairman Ben Bernanke announced last week that the Federal funds rate will stay near zero for now. He reasoned that the "low rates of resource utilization and a subdued outlook for inflation over the medium run" would likely "warrant exceptionally low levels for the federal funds rate at least through mid-2013."

This will likely translate to the real interest rate (which is the rate of interest an investor can receive on a U.S. Treasury bill after allowing for inflation) remaining negative for at least another year and a half.

For gold investors, a low-to-negative interest rate has been associated with a powerful historical trend. Going back four decades, gold has experienced positive higher year-over-year returns whenever the real interest rate tipped below 2 percent.  And the lower the rates drop, the stronger gold tends to perform.

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Marc Faber, editor of the Gloom Boom & Doom Report, believes the Fed will keep rates near zero even longer than 2013. In his November commentary, he points to the opinion of Chicago Federal Reserve Bank President Charles Evans, who wants the Fed to "commit itself to keep short-term rates at zero until the unemployment rate falls below 7 percent or the outlook for inflation over the medium term goes above 3 percent." If Evans has his way, Dr. Faber extrapolates that rates could "stay at zero for five or even 10 years (and negative in real terms)." Based on Dr. Doom's prediction, one could infer that gold could continue its bull run for several years to come.

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This rate-cutting trend is not only an American phenomenon, as other countries have been slashing their interest rates. In surprise moves, the central banks of Europe, Brazil, Indonesia and Turkey have all recently cut rates. This week, the European Central Bank surprised markets when it cut its key interest rate by 0.25 percent. Brazil has cut rates twice over the past two months, and Turkey cut its benchmark interest rate a few months back as part of an unorthodox move to keep its economy from overheating.

Many investors follow the Fed's decisions, but to see countries' rate changes in action over the years, The Wall Street Journal put together an interesting interactive showing how countries around the world have increased or decreased their interest rates over the past several years. Check it out now.

The other strong action central banks have been taking is loading up on gold.


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