The following chart shows the natural log of the quarterly average of the 10-year treasury yield. When using natural logs, constant exponential growth (or decay) is seen as a straight line.
Click to enlarge.
I have added a parabolic trend channel in red that uses the data points shown in red. I have also added a parabolic trend in blue that uses all of the data points. Note that the correlation of the blue trend line is 0.89.
The long-term trend shows that the 10-year treasury yield has been decaying (not exactly rocket science here). It's not a pure exponential decay though. Since a parabola fits the data extremely well, I think the best way to describe it is as an exponential decay trend that has been accelerating to the downside. In other words, it has been exponentially decaying at a faster and faster rate. Hello Japan?
I know past performance is not necessarily indicative of the future, but where is the actual evidence that we are in a long-term rising interest rate environment? (And not just a short-term cyclical bounce within a declining trend channel?)
You may be wondering why I singled out the 5% interest rate target in the chart (with a natural log of 1.61). Well, wonder no more! It is inspired by the financial "experts" at MSN Money. Long time readers know that I'm not all that bullish on inflation adjusted gold prices at these levels, but I believe that the following article is a study in ridiculousness. I am therefore willing to place a "gold bug" hat on my head, if only for a day. You know, it's just an effort to balance things out a bit.
January 22, 2014
MSN Money: How gold could fall below $500 an ounce
If the 10-year Treasury yield rises to 5 percent, gold will fall to $471 an ounce.
If ifs and buts were candy and nuts then we'd all have a Merry Christmas. What hubris! The price of gold is pegged to 3 digits of "scientific" precision. All you need to know is a future long-term nominal interest rate? Forehead. Desk. Whack. Whack. Whack.
To be sure, a comprehensive model of gold's price needs to include more than just interest rates.
You think? Yeah, inflation might be a good backup plan if nominal interest rates aren't enough I suppose. For example, if inflation is running at 10% and the 10-year treasury yields 5% then I think we can pretty much forget about $500 gold. Call me silly if you must. (This is not a prediction that we will see 10% inflation and 5% interest rates of course. It's just an example.)
But, according to Claude Erb, who conducted these statistical analyses, we should not be too quick to reject his simple "behavioral" model relating gold's price to the 10-Year Treasury yield.
I wish you could have seen how quick I was to reject his simpleminded "behavioral" model. It may have even been a personal best! Unfortunately, I did not have a stopwatch at the time. And even if I had a stopwatch handy, I'm 49 years old and my reflexes aren't what they once were. I'm therefore not entirely sure I could have accurately timed such a short period to 3 digits of "scientific" precision.
In the case of the gold-interest rate correlation over the last decade, Erb told me in an interview, the r-squared is a very high 0.78. ( Click here for a summary of his findings. )
Most correlations on Wall Street don’t come anywhere close to being that high. Indeed, many of the drugs that get FDA approval have lower r-squareds between their use and positive medical outcomes.
Wow! 10 years of cherry picked data offered up a very high 0.78! Color me impressed. Of course, it is based on the premise that my 28 years of cherry picked data (as seen in the chart above) with a much higher 0.89 correlation has to fail spectacularly before his prediction even kicks in. In order to get to 5% interest rates, the natural log needs to rise to 1.61 on my chart. That is well outside the channel and well removed from the blue trend line. It would indeed be a spectacular fail. Could it happen? Of course it will, someday. That someday could be a very, very long time from now though. And in the meantime, who really knows what gold will be doing?
So, in the battle between cherry picked data sets, who are you going to believe? The very highly correlated 10 year model for gold's price that does not concern itself with inflation or the extremely highly correlated 28 year model of long-term interest rates that has a certain Japanese housing bust feel to it?
Put another way, if one assumes that we are in a rising interest rate environment when we very well might not be, then all kinds of crazy predictions are possible. Why stop at 5% interest rates? What will gold's price be if interest rates hit 50%? Better not tell me $47.10 or I will laugh my motherf#$%ing @$$ off! Seriously, lol.
This is not investment advice. I'm simply offering up an alternative theory for where interest rates are headed that matches my own beliefs. It is not proof of anything. If I had a crystal ball that could accurately predict the future, then I certainly wouldn't spend time making charts or offering up gold price predictions with a whopping 3 digits of "scientific" precision. Now would I? No, sir. I'm compelled to heckle instead. It might even be a disease. Please, for the love of all that's holy, someone help me stop! :)
See Also:
The Pulp Fiction of Rising Interest Rates
Source Data:
St. Louis Fed: Custom Chart
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