Gold and TIPS strength ratio. In real rates the reason for gold’s rally?
Last Update: 25/12/2024
The strength ratio between gold and Treasury Inflation-Protected Securities (TIPS) can give useful insights into inflation expectations, confidence in the ability of government bonds to hedge inflation risk, and, last but not least, real rate trends.
On the first point, the explanation is very simple. Gold has historically been considered a hedge against inflation. When inflation or inflationary expectations rise, the price of gold tends to rise. TIPS are U.S. Treasury securities that offer protection against inflation, as their principal value increases with inflation as measured by the Consumer Price Index (CPI). An increase in the ratio of gold to TIPS could signal rising inflation expectations because it suggests that investors see gold as a better hedge than TIPS.
When the gold/TIPS ratio rises, we are at the second point, this could also indicate a growing distrust in the ability of government bonds to protect capital, especially in times of high inflation or financial crises.
The third interesting aspect is that of real interest rates, that is, yields net of inflation. The price of gold is inversely related to real interest rates. When real rates are negative or low, gold becomes more attractive because the opportunity cost of holding gold (which does not generate interest) decreases. The gold/TIPS ratio may indicate changes in the perceived value of real rates: if the ratio increases, it may mean that real rates are expected to fall or that gold is gaining more attractiveness as a “safe haven asset.”
Having made this long introduction to explain the contents of this strength ratio, let’s go and see what it is indicating right now and whether, from reading it, we can understand a little more about why gold prices are rallying.
Here it is, then, the relationship between gold and tips. We can see how from the beginning of 2022 the indicator accelerates upward and how, from the beginning of 2024, it further increases the speed of the upward movement. While it is fairly easy to interpret the first part of the movement (the one from 2022 to 2024, that is, during the period of high inflation expectations), it is more interesting to interpret the last 10 months.
On the one hand, gold continues to be seen as a safe haven asset, and is supported by high demand from central banks and geopolitical uncertainty. On the other hand, TIPS is discounting a more accommodative monetary policy combined, however, with an inflation rate that is more persistent, and this means lower real rates.
Here then is an interesting key to the gold rally. Lower interest rate expectations combined with higher inflation expectations reduce real rates and make gold more attractive as a tool to protect capital.
