Last Wednesday we commented on Reserve Bank Govenor Bollards recent announcement to hold NZ interest rates as they are. And his comment that “Should the exchange rate remain strong without anything else changing, the bank would need to reassess the outlook for monetary policy settings.”
What will the Reserve Bank of New Zealand do in coming months? Will rates stay as low as they are for the foreseeable future? Beats us. (We’ll actually the contrarian in us says they could go lower yet but who knows).
Obviously the interest rate has a bearing for those New Zealanders with a mortgage and businesses with loans. But rather than focussing on Dr B’s announcement every quarter we think there is a much more important interest rate to keep an eye on.
That is, what is the current “Real Interest Rate” in New Zealand.
Well, the real interest rate is simply the interbank lending rate less the current rate of inflation.
Why is this so important?
Because it shows you what return you are getting on your money after inflation. When this number gets below 2% and in particular below zero (also known then as a Negative Real Interest Rate) this is when it is a good time to hold gold.
Why is that?
Because there is then no opportunity cost in holding gold. As the gold haters like to remind you, Gold pays you no interest. But when the bank pays you no interest (or next to none) it makes sense to swap your cash for gold instead. As in this kind of environment, you stand a much better chance of maintaining your wealth and your purchasing power with gold.
We’ve seen real interest rate charts before but generally featuring what US rates are. So we were going to put together a chart of New Zealand Real Interest Rates. However just recently we were over at Greshams-law.com and stumbled across the exact chart we were looking at creating, so we thought no need to recreate the wheel! Plus “Mr Gresham” updates these pretty regularly. (By the way there’s some great articles on Greshams-Law.com so head over there for a good look when you’ve finished here.)
(The definition on Greshams-Law.com for ‘real’ interest rates, is the short-term inter-bank rate minus the year-on-year growth in the consumer price index. The CPI rate comes from the OECD statistics so of course this data is only as good as each government CPI measure which likely means inflation is actually higher than this.)
The chart shows real interest rates along with the local NZ Dollar gold price. NZ real interest rates were deeply negative last year when inflation in NZ was higher. (They’re currently back around zero.)
You can see that over the past few years the NZ dollar gold price has been trending up, while real interest rates have been trending down. This is the very relationship we discussed earlier, that is when real interest rates are negative – or close to it – gold generally performs well as there is no opportunity cost in holding gold.
At the moment NZ real interest rates have turned back up due to lower inflation rates in New Zealand in 2012. The chart hasn’t been updated with the latest Gold pricing in NZD, (seems it only goes up to about October 2011) but it has dropped away during this period, currently it sits at just over $2000NZ per ounce.
So we’d say it makes sense to keep an eye on this chart, as even if interest rates begin to rise as they inevitably will, it’s possible for “real” interest rates to stay negative or close to zero, while nominal interest rates rise. Because inflation might well be rising at the same time at faster rate than the interest rate rises. So it’s likely that gold in NZD will still be the place to be while this is going on.
This is what happened in the 1970’s – interest rates were very high, in the teens in fact, but inflation was even higher and so gold was rising while nominal interest rates were rising. But in fact real interest rates were remaining negative.
So ignore any comment about how rising interest rates are bad for gold as it is the Real Interest Rate that matters.
But with the US Federal Reserve promising to keep interest rates at almost zero until 2014 it’s likely New Zealand may have historically low interest rates for a while yet too. So even if the rate of inflation stay low, the NZ real interest rate will remain close to zero – certainly under 2% – and this is likely to remain positive for gold.
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For more on real interest rates check out this article:
Golds critical metric – the one indicator to watch