More on Interest Rates and Gold

More on Interest Rates and Gold  

The price of gold dropped about $15 within a minute of the release of the October nonfarm payroll report data last Friday, based on speculation that the Fed would begin to raise rates next month. That's life in a centrally planned economy, where the most important price of all-the price of money-is fixed by the central bank.

But there's a flaw in this logic as noted by Keith Weiner of Monetary Metals (https://monetary-metals.com/a-14-handle-on-silver-again-14-nov-2015/). The price of gold does not correlate
with short term interest rates, as noted in our post of last Saturday. Here's more on that theme from Monetary Metals. In the 1970s, a rapidly rising price of gold went along with skyrocketing interest rates. In January of 1970, you could buy an ounce of gold for $36.56. By December 1979, the price was up to $593.84, a 16-fold increase. More than half of this gain occurred from 1977-1979 when the price rose from about $132 to $594 while the interest rate on the 1-year Treasury Note more than doubled from under 5% to almost 12%.

Here is a graph from Monetary Metals overlaying the gold price with the Fed Funds Rate.

The co-basis is the difference between selling gold at the spot bid price and buying gold at the front contract asking price. Normally, this is an unprofitable trade because normally gold trades in contango, meaning that the future price is above the spot price. When the co-basis trade is profitable (that is, when the co-basis is positive), it indicates to us that deep pockets are willing to buy physical gold at a premium and pay to warehouse it in expectation of scarcity and higher prices or possibly counterparty concerns.

The co-basis trade involves temporarily trading dollars for gold. The fact that this trade is profitable indicates a preference on the part of the buyers for holding gold versus dollars. Normally, physical buyers would bid for gold at a discount to the future price so they could lock in a profit in the futures, or at least hedge themselves.

The following chart shows a steeply rising co-basis (red line) which is highly correlated to a rising dollar in terms of gold (green line). As the gold price falls in dollar terms, investors appear to be hoarding physical gold. The co-basis has hit a new high for the year in percentage terms, indicating a growing preference for holding gold.

In our view, the gold co-basis is telling us that there are deep pockets positioning for a move lower in the dollar and higher in gold, just as they did last September.