As our regular readers will know, we view US real
interestrates as the key determinant of gold prices over the medium term. Six weeks ago we updated the situation with U.S. real rates (discussion of the theory behind the relationship can be found in that article) and since then, we have observed the gap between gold and real rates closing.
At the time of writing in our December update, gold had bottomed from its biggest correction since September. Since then the precious metal has regained some ground, especially in the last few days on the back of the latest Federal Open Market Committee (FOMC) announcement.
On Wednesday the 25th of January, the Fed extended their low/zero interest rate policy through 2014. The initial commitment to keep interest rates at zero was made in August 2011 and was intended to run no longer than mid 2013. Extending the policy to 2014 is acknowledgement of the situation the U.S. and the world is facing this coming year. They also talked of targeting 2% inflation, which was something the market already had already taken into consideration. As a result of the announcement, interest rates have dropped across the curve with 10 year TIPS (real rates) dropping almost 20 basis points in the two days since the announcement.
However we must point out that the Fed saying that interest rates will be low through 2014 is not really a factor that will drive goldprices
to new all time highs. More aggressive monetary easing will be needed for this to be achieved. The market is currently pricing in a greater expectation of aggressive monetary easing, hence why gold prices are rising, but, such easing is guaranteed.
Taking a look at the recent gold rally, the metal is now trading closer to where we would expect it.