Paradox - Revisited
preparing for this week's Goldseek.com
Radio, my attention was drawn to a little known
economic theory proposed by a British economist 90 years
ago. In 1923 Alfred Herbert Gibson published a paper
regarding the negative correlation between interest
rates and inflation in Banker's Magazine (White,
2011). John Maynard Keynes later coined the term
Gibsons Paradox in 1930 (Keynes, 1930). Unlike
his contemporaries, Keynes embraced Gibsons finding
as one of the most established and profound in the field
of economics. I concur Gibsons Paradox deserves
to be recognized as an economic law, not merely a theory.
researchers proposed that Gibson's Paradox explains
much of the price movement in the gold market (Summers
& Barsky, 1988). Research indicates that the
gold price and real interest rates are highly negatively
correlated - when rates go down, gold goes up. It has
been rigorously back-tested and stands the test of time
via not only theoretical evidence, but empirical research.
In fact, regression analysis reveals a very high f-statistic
which adds statistical support to the notion - when
real interest rates are below 2%, a bull market in gold
is virtually certain.
experimental and experiential evidence validates Gibson's
Paradox, how come the theory isn't widely recognized? It's
likely that the mainstream media and academia have been
reticent to accept and assimilate Gibsons Paradox
due to a simple misconception. The generally accepted real
interest rate or rate of return is not negative, and so
a gold bull market is not anticipated.
should analysts / economists determine the real interest
rate? The real interest rate is the nominal rate that investors
expect to receive, i.e. the long term treasury bond coupon
or rate less the inflation rate. Since the U. S. Treasury
earns 3% per annum, the real interest rate is 3% minus the
annual rate of inflation. John
Williams Shadowstats.com indicates a domestic
inflation rate of 6-8%.
To verify his work, one can calculate the annual growth
rate in the Treasury
Inflation Protected Securities TIPS ETF from the IPO
date in 2004 until 2012. The TIPS ETF indicates a 6% (approximate)
annual inflation rate, very close to John Williams
figure. So to determine the real rate of return, the 6%
inflation rate is subtracted from the 3% treasury yield,
resulting with a real interest rate of -3%.
Gibsons Paradox offers a gold price forecast for the
next 12 months (White,
2011). The rule states that for every percentage point
the real interest rate (-3%) is below 2%, gold will increase
in value by 8%. As calculated in the last paragraph, the
real interest rate is assumed to be -3%. Since -3% is 5%
below the 2% threshold, 5 percentage points times 8% provides
the gold forecast for the next 12 months: 5 x 8% = 40% .
The current gold price is near $1,700 - leading to a gold
price forecast of: $1,700 x 1.40 = $2,380. Anecdotally,
$2,380 coincides with the 1980 inflation adjusted, peak
a healthy modicum of skepticism is wise for every investor.
Next a very cursory back-test of Gibsons Paradox is
illustrated in Figure 1.1. Assuming that rates entered negative
territory in 2001 and have remained there ever since, resulting
with a constant real interest rate of -0.5%, gold should
have performed as follows:
1.1. Gibsons Gold Law - Back-test:
the numbers above look familiar? Clearly the back-test
shows a high correlation to the true bull market price
advance - Gibsons Paradox holds. Assuming the same
negative real interest rate of -0.5% (2.5% below the threshold
resulting with 2.5 x .08 = 20% growth per annum) Gibson's
Paradox provides a gold forecast in Figure 1.2 (White,
Figure 1.2. Gibsons Gold Law - Forecast:
$1,700 x 1.2 = $2229;
2013: $2229 x 1.2 = $2675;
2014: $2675 x 1.2 = $3210;
2015: $3210 x 1.2 = $3851;
2016: $3851 x 1.2 = $4622;
2017: $4622 x 1.2 = $5,547.
if real interest rates remain even fractionally negative,
given the precepts of Gibsons Paradox, the price
of gold should surpass $5,500 by 2017. However,
there are many factors that can skew the actual forecast
outcomes. For instance, the real interest rate is volatile,
which will result in varied annual gold price forecasts.
The Gibson Gold Forecast is intended only as a guide.
Nevertheless, gold investors are urged to regularly calculate
the real, inflation adjusted interest rate to verify that
it is below 2% and particularly that it remains below
0%, to satisfy the ideal conditions for higher gold prices.
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J., M. (1930). A Treatise on Money. Macmillan.
(2011). Gold poised for upside breakout of current range.
Summers, L., &
Barsky, R. (1988). Gibson's Paradox and the gold standard.
of Political Economy, 96(3), 528-550. Retrieved from
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