Precious metals saw a pop versus equities on debt ceiling deal

Market Realist

Why gold beat equities post–debt deal

The SPDR Gold Shares ETF (GLD) was up 3% yesterday following Congress and the White House reaching a deal on the debt ceiling. Other precious metals ETFs such as the iShares Silver Trust (SLV) saw similar gains. Precious metals have been volatile as of late, and it’s useful to review the drivers of investment demand for these products to understand why.

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Gold is thought of by some investors as a “safe haven” asset that people flee to in times of uncertainty. While this is sometimes the case, looking at the data leads you to a much more straightforward conclusion: gold is a play against the dollar and real interest rates. When the dollar and real rates fall, gold rallies, and vice versa.

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In light of this, it’s best to think of gold as a currency, and relative demand for currencies is driven by interest rate parity, or the relative differences between the interest rates currency traders can receive by holding different countries’ currencies. Gold has a real interest rate of zero, so when real rates are negative, holding gold has a lower opportunity cost.

The main takeaway is to watch the Fed and the yield curve

What does all this mean for investors interested in gold? It means the Fed is still the main driver of the metal. With the debt ceiling only extended until February, the likelihood of a December taper is now much lower, since by now it’s clear that the Fed is sensitive to fiscal policy. This means that rates are going to stay lower for longer, which is bullish for gold.

Despite the Fed, the trend in rates has been upward for much of this past year. It’s difficult to recommend more than a token portfolio allocation to gold and other precious metals in light of their poor relative performance to US equity ETFs such as the SPDR S&P 500 ETF (SPY). Other precious metals besides gold have seen better performance as well due to industrial factors such as the ETFS Physical Palladium Shares ETF (PALL).

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