Why Is Gold a Solution for Today?
In today’s post, I will explain to you the ten-year treasury note and real interest rates. What is their role in the gold investment thesis, and ultimately, why does gold protect you against inflation?
What is the ten-year treasury note?
Imagine that you are a risk-averse person when it comes to your money. You don’t like a risk at all, but at the same time, you would like to receive interest in your savings. In the financial world, the ten-year treasury note would meet your requirements, it is considered risk-free. You lend money to the US government in exchange for an interest, and at the end of the decade, they will give you your money back. Uncle Sam is like the Lannister family; they always pay their debts.
However, to decide if this is a good deal or not, you have to compare the interest of the ten-year against the rate of inflation, which reflects the devaluation of the currency.
What are Real interest rates?
That is the difference between the ten-year interest and the rate of inflation (TN – CPI). If your currency devalues at 2%, but the risk-free ten-year interest gives you back 3%, you are coming ahead with 1% each year. This is the value of real interest rates, and it could be a better deal than leaving the money in the bank.
In a healthy economy, real interest rates are positive (TN > CPI). That is the way that the system rewards savers over spenders. Saving is the fundament of a capitalist system. Without saving, our modern economies would collapse.
But sometimes, real interest might become negative (TN < CPI). In this scenario, savers are giving money to the US government and losing money in the process. This is a sign of an unhealthy economy, you lend money to the government, and your money devaluates faster than the interest that money is giving you back.
This is the current situation in the world. Inflation (CPI) is much higher than the ten-year interest (TN), and people are encouraged to spend rather than to save. The more you save, the more money you leave behind due to inflation. But What about those that still want to save after all? They can invest in gold and gold equities.
Why does gold protect against inflation?
For thousands of years, gold has been used as a form of money, from before the Roman empire until nowadays. Gold is associated with something valuable, a fact that even reflects in some languages. In Czech, for example, the word darling derives from the word gold.
Gold has two cool characteristics. First, it is scarce; there is not so much gold around, which makes it valuable. And it is also so chemically stable that it is barely indestructible. All the gold mined through history is still with us. Like that Nokia 3210 that you could throw off the window and still play snake afterwards. Because of the scarcity and indestructibility, the gold supply cannot be inflated quickly, therefore keeping its value stable. Notice here that I said value and not price.
The opposite happens with currency. To print new money is very easy. Governments print money when they need to, which depreciates the currency value. It is like adding water to a wine barrel. You don’t have more wine; you just have a less valuable one. Gold, however, stores that value for you.
Below you can see when the Real interest rates (blue line) cross to negative ground, Gold (orange line) raises in price.
Today’s economic landscape.
As a reaction to Covid, all countries around the world have sent their debt over the roof. The US currently has a 133% debt to GDP. As a consequence, inflation is going over the roof too. The way to tackle this would be to raise interest rates above the inflation rate. But if they would do so, the cost of paying their debt would skyrocket. The interest of their bond would rise, and they would end up bankrupt.
The opposite situation would be to let inflation run freely or raise interest rates a little bit to save face. Leaving Real interest rates in negative territory. This would be good for gold, as we explained.
So, in the end, we should consider what is more probable: the US government raising rates above the inflation rate, crashing their economy, and filing for bankruptcy. Or the US raising rates a bit, and sticking with high inflation.
In conclusion, in today’s world, the problem with inflation cannot be solved, and eventually, that will force the market to turn into gold and gold equities. This is why part of my public stock portfolio is allocated to Gold mining stocks. If I believe the price of gold is going to rise, I believe too that the price of mining stock will rise as well, giving me back a return that at least, will make up for inflation.
This is not investment advice but an idea that can get you started on your own research. And in the end, if this resonates with you, take action. You can listen to the following channels and investors on Youtube: Rick Rule, Lobo Tigre, Alasdair Macleod, Resources talks, Palisades gold Radio, and ABC bullion.
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