Buy gold on North Korea?

BY DEB SHAW | 

  • North Korea is in the headlines again, time to buy gold?
  • Tensions in the Korean Peninsula have only led to short-term gains in gold prices
  • For a longer term picture of gold, consider real interest rates

With North Korea in the headlines again, the allure of gold’s safe haven qualities makes it look like a wise purchase. Gold has rallied several times in 2017 on North Korea-related news headlines, given escalating rhetoric from both Donald Trump and Kim Jong-un. Yet gold prices have not been able to break out, and remain trapped in range between $1,050 and $1,350. The precious metal made its most recent high on September 8, when it traded above $1,350. Today, gold is trading around $1,280, having strengthened from its most recent bottom near $1,268. Will Trump’s latest tweet claiming that talks haven’t worked and “only one thing will work” help gold prices break out of its current range?

 

North Korea and gold, a short-term relationship

Looking at news headlines in 2017, gold prices have had mixed reactions to North Korea-related tensions. The precious metal rallied as tensions escalated in early August, following Trump’s suggestion regarding a “military solution” and a North Korean missile test directly over Japanese soil. However, gold failed to sustain its rally and weakened in the last few weeks of September, despite new provocations on both sides. While the North Korean issue remains in the background (Trump hinted again at a solution to North Korea that does not involve talks earlier this morning), gold appears to have mixed reactions to political tensions. This is visually highlighted below:

Sometimes up, sometimes down

10-9-2017 Gold North Korea
Source: Twitter, Reuters 

 

A better explanation for gold prices

Instead of rising and falling political tensions, a far better means of  predicting gold prices is to look at the precious metal’s sensitivity to real interest rates. As we wrote last week, "Gold has historically traded inversely to US inflation-indexed interest rates. In short, gold becomes less attractive relative to bonds as after-inflation yields rise, while becoming more attractive as after-inflation yields fall." Unlike bonds, which trade based on nominal interest rates, gold prices are sensitive to both nominal bond yields and inflation. The relationship between gold and real rates can be seen clearly below:  

Gold rises and falls with real interest rates

10-9-2017 gold real rates

 

Gold can rally on government spending, but probability of war remains remote

Today the realistic prospect of war with North Korea is still remote, and gold prices remain subdued accordingly. Elevated government spending (especially during war) has historically been a significant source of inflation, especially when coupled with low growth. As US government spending makes up 38% of total GDP according to the OECD, a big increase in spending is enough to catalyze rising inflation. If the Fed failed to hike interest rates following high inflation (in order to finance war spending, for example), gold prices are likely to jump higher. 

Instead of war, investor optimism today is driven via the increasing likelihood of Trump pushing through tax reforms and fiscal spending plans. If real rates fall in the future (i.e. if inflation rates rise faster than future interest rates), gold prices can rally from here.

Topics: Gold
Tags: Inflation

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