As inflation continues to fluctuate, recent Consumer Price Index (CPI) data and Federal Reserve policies are raising questions about the future of gold and silver prices. As of July, CPI is at 2.9 percent. This is hugely important, specifically for real 10-year Treasury bonds. The other big variable is what the Federal Reserve does with rates, which would dramatically reshape the market landscape. Consequently, investors should reconsider their approach to precious metals.
Revisions to the Consumer Price Index (CPI) have been frequent since the 1990s. This narrower measure of inflation focuses on the average price change over time. These modifications and adjustments have triggered controversies over whether inflation is being accurately measured. Critics contend that the new formula doesn’t take into account what really is happening with prices. They go on to argue that the true inflation rate is much higher than claimed. Notably, had the government continued using the CPI formula from the 1970s, current inflation figures might be closer to double the official numbers.
Understanding Real Interest Rates
Real interest rates are a key factor in shaping the logic of investor choices across financial market instruments. They show the real return on investment, or return on investment after the effects of inflation have been removed. When considering the specific case of 10-year Treasury bonds, real interest rates are affected almost immediately by CPI data. When CPI inflation is 5 percent, but the 10-year Treasury bond only pays 3 percent, then the real interest rate has gone negative. This makes up for it, leading to a net lifetime discounted value of -2 percent. Given this negative real rate, we have fostered an environment where holding cash or low-yielding assets is disincentivized.
With a CPI of 3.5 percent and a bond yield of 4 percent, the real interest rate improves to 0.5 percent. This means that even after inflation begins eroding purchasing power, investors can still find significant reasons to hold these bonds. As of June, the Consumer Price Index (CPI) is 2.9 percent. As the Fed funds rate currently at least 1.6 and as high as 1.25 percent above this CPI, bondholders are reaping a better real rate right now.
The relationship between CPI and Treasury yields makes an important difference to investors in precious metals such as gold and silver. When real interest rates go low or negative, demand for gold and silver increases. Investors are looking for these precious metals to diversify away from the dollar and provide a hedge against inflation of conventional fixed-income investments.
Federal Reserve Policies and Market Reactions
Because the Federal Reserve’s position on interest rates strongly affects market expectations for inflation and asset prices, most recently, Fed Chair Jerome Powell pointed to the need for more cuts given the persistent economic headwinds. These cuts could create a harmful negative real interest rate environment if they are implemented in concert with an ongoing trend of low CPI readings.
The ramifications of these possible cuts go way past the bond market. With two or three more rate cuts likely, analysts expect that real interest rates might go negative again. This situation is incredibly positive for gold and silver investors. As we’ve long argued, historically, for these precious metals to thrive they need to find themselves in low or negative yield environments.
Cautious market reactions to Powell’s comments have already started to last week. Investors are closely monitoring CPI shifts and Fed policies as they position themselves in anticipation of future price movements in gold and silver. If inflation remains flat and interest rates decline, a perfect storm may be in the making for precious metals. Likewise, they could catch on as popular safe-haven assets.
The Broader Economic Context
The bigger economic picture around CPI measurements and interest rates deserves some focus too. Many economists and analysts argue that the current CPI might not fully capture the economic realities faced by consumers today. This mismatch begs the question of how well policymakers are able to read emerging trends in inflation and shape monetary policy in response.
As inflation expectations change, so will investor sentiment towards any number of different asset classes. If inflation as measured by CPI remains muted and the Feds persist with rate reductions, gold, silver and other commodities may start looking attractive as investments. Investors concerned about inflation protection in the long term should not ignore these inflation-linked investments.
Moreover, with growing skepticism about the reliability of CPI data, some investors may turn to hard assets as a means of preserving wealth. For centuries gold and silver have been a natural hedge against currency depreciation and inflation. During turbulent economic times, these metals become particularly attractive assets for investors to flock to.