Almost four months ago, I penned a note to subscribers of EPB Macro Research that said I was cutting my exposure to gold to the minimum allowable exposure for the model portfolio strategy. The reason I reduced the position in gold was that the outlook was for the Federal Reserve to continue raising interest rates and reducing the balance sheet, which would surely push short-term rates higher. Since cutting this exposure almost four months ago, gold has fallen nearly 10%.
Gold trades inversely to interest rates. Most of the time, if interest rates fall, gold will rise, and if interest rates rise, gold will fall. There are other factors that play a minor role, such as inflation and the US Dollar, but the direction of shorter-term interest rates is most important.
The reason for the inverse correlation between gold and interest rates stems from the opportunity cost of holding gold which is short-term interest rates.
When short-term rates are ready to move lower again, gold will start to reverse. I will go into more detail below as well as discuss if now is the right time to start buying gold after the recent declines.
For much of the following analysis, I will be using the SPDR Gold Shares ETF (GLD). GLD is the easiest replacement for physical gold in a portfolio as the ETF is backed by physical gold holdings and the price nearly exactly matches the underlying asset as shown below.
GLD Vs. Gold Price % Change:
Reference: Seeking Alpha
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