Atlas Pulse report thought experiment: Consider gold as a ‘bond issued by gold’

Atlas Pulse is for our mind simply the best monthly gold (and crypto!) report around. Below is a snippet from the latest report, and as usual some off-the-wall thinking brings Atlas Pulse to ask us to consider the gold price as a bond – some very interesting food for thought.

The full report can be downloaded here:

A bond issued by God

Going back to rates, you won’t be surprised to learn that I’ve modelled the gold price as if it were a bond. Consider the following statement:

Gold is a zero coupon, irredeemable, inflation-linked bond issued by god.

Zero coupon means it pays no interest.
Irredeemable means it has a long time horizon.
Inflation linked means it is a store of value.
Issued by god means it is an element that will never disappear or default.

The US consumer price index (CPI) is currently 237. If 30 year inflation expectations are 2%, the market believes CPI will be at 429 in the year 2044. That is a nominal return of 81% and a real return of zero. To put it another way, the market currently believes the dollar will fall by 45% over the next three decades in terms of purchasing power.

What would you pay for that investment opportunity?

For a positive real yield, you would want to pay less than 237, so that your return would be higher than 81%. If real yields were 1%, you would want to pay 171 otherwise bonds would be a better bet. (stick with me, this is just theory)

So I’ve pretended that gold is a bond driven by current CPI, 30 year yields and 30 year inflation expectations.

atlas pulse gold as a bond(click for sharper image)

Chart note: This model charts the statement that the gold price is a function of real yields, inflation expectations and CPI. Since 1998, CPI has risen by 45%. The impact of the 30 year yield falling from 5% to 3% has contributed 75% whilst higher inflation expectations from 1.5% to 2% have contributed 20%. Putting these together explains why $100 invested in 1998 is today worth $400 which is more or less the same return from investing in gold. If this statement is true, gold was too cheap in 2005 and too expensive in 2011. Notice how gold leads the model, ever so slightly.

I like this idea. Having struggled to get a consistent message from studying the two’s (2 year bonds), inflation, rates and so on, this seems to fit like a glove. 30 year inflation expectations are only available since 1998, so sadly we will never know what people thought before that time. I have also looked at this in Canadian dollars, British pounds, Mexican Pesos and Brazilian Real. There is also data from Italy but it doesn’t work at all due to the sovereign debt crisis. These studies generally suggest that the gold price is about right except for the sterling model. In that case, the pound is significantly overvalued and could be in for a nasty shock.

All in all, gold has reverted back towards this bond model. It will probably overshoot as investors panic, but I hope you will agree that this is one of the better ideas Atlas Pulse has published.

I will leave you with some scenario analysis in the following table. It has been calibrated to current data with the 30 year yield at 3% and inflation expectations at 2%.

atlas pulse gold as a bond a(click for sharper image)

Table note: If you want to see gold go to the moon, pray for Japanese long term interest rates (1%) combined with Argentinian inflation. If you want to buy gold cheaply, then hope that that rates increase in an inflation free world.

During the credit crisis, the 30 year went to 2.5% and inflation expectations to 1%. A repeat would imply a 39% fall from current levels. Fortunately, that won’t happen because gold will enjoy a doomsday premium during such times so the impact will be less.

In the late 1970s expectations were (presumably, more on this next month) around 6% with yields close by. A repeat of that scenario would see gold trade above $5,000. Of course this is just a model, but I like it.

Link to this article: : http://www.goldmadesimplenews.com/gold/atlas-pulse-report-thought-experiment-consider-gold-as-a-bond-issued-by-gold-12779/

Posted by on Dec 12 2014. Filed under Gold News. You can follow any responses to this entry through the RSS 2.0. You can skip to the end and leave a response. Pinging is currently not allowed.

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