Fed Up with Low Interest Rates?

November 16 2015

There’s no shortage of savings accounts, but interest payments are nowhere to be found. I face the ugly truth almost every week: yet another email that the yield on my savings account has been "adjusted" (and guess what that means!). It seems I should consider myself lucky to receive a mere 1% interest on my savings. So I wondered: is there a better alternative?

When Will This Change?

There is only one reason that the interest rates are so low: the current monetary policy. The European Central Bank (ECB) is responsible for the lowest interest rates in history. Believe it or not, but interest rates have never been this low in the past 500 years.

Can we expect higher rates on savings accounts anytime soon?

In my opinion, absolutely not.

Even if inflation were to rise, which would deplete our savings even further, Mario Draghi (President of the ECB) wouldn’t even think about raising interest rates. Government debts are simply far too high. Europe and the euro are doomed if interest rates were to rise: debt service costs would skyrocket.

In short, you can count on low interest rates and losses in purchasing power, as long as those debts are not restructured.

How Do I Earn More than 1% on My Capital

Due to the low interest rates, we are forced to look for alternatives. But there are few good alternatives. As the rates have declined, it rendered many investments too expensive already, which means that future returns can only prove disappointing.

  • The stock market? Overpriced.
  • Yields on government bonds? Even lower than rates on savings accounts (or even negative!).
  • Real estate? Expensive, risky and complicated.

And then I found this graph:

Year Return in EUR
2001 +6,2%
2002 +6,5%
2003 -0,3%
2004 -2,9%
2005 +35,7%
2006 +10,2%
2007 +19,0%
2008 +9,7%
2009 +21,1%
2010 +38,2%
2011 +12,6%
2012 +6,6%
2013 -28,3%
2014 +12,1%
Average +10,4%

 

Take a guess: what investment matches these returns? Real estate in Costa Rica? Teakwood from Brazil? A Picasso?

No, no and no.

The right answer? Gold. And it isn’t going to get much better than this:

  • An average return of +10%
  • In 2013 was its only strong decline (but to put it in perspective: it declined less than the Dutch AEX index did in 2008, which declined by -52%)
  • Easy to invest in, and it is a liquid investment (no annoying tenants, annual reports or whimsical managing directors)

Moreover, gold is not a hype. Or you would have to argue that gold has been a hype for six thousand years (which is what the Dutch leading economist Willem Buiter did say). But that wouldn’t do justice to reality.  

So, Should I Buy Gold?

But to be frank, I am not someone who gives in easily, and I hope you don’t either. How likely is it that we will see these amazing historical returns again in the coming years? I will spare you platitudes such as 'past performance does not guarantee future results,' but you understand my point.

I stumbled upon a paper from an economist called Larry Summers.

You are probably thinking: "Larry who?"

His full name is Lawrence Henry (Larry) summers. He was the Minister of Finance under President Bill Clinton. And he is one of Obama’s most important economic advisors. Back in 1988, when the Netherlands did participate in the European Football Championship (and even won), he wrote about the forces driving return on gold. This masterpiece was published as Gibson’s Paradox and the Gold Standard (click here).

Summers will not be shouting it from the rooftops, but his words are clear:

"(...) changes in long-term real interest rates [corrected for inflation] are indeed associated with movements in the relative price of gold in the opposite direction and (...) this effect is a dominant feature of gold price fluctuations (p. 548)

In simple terms: if interest rates are high, the gold price will decline, and when interest rates are low, the gold price will rise.

Now we can begin to understand the great past returns we have seen above. It is because interest rates have been at a historical low since 2000.

And interest rates will remain low for the coming time, considering the enormous amount of debt that has been accumulated.

What Can We Expect from Gold?

Another sharp-eyed investor also noticed this trend, and proceeded to make a smart call. He collected all historical interest rates and gold prices, divided interest rates in seven classes, and observed what the average return on gold was per 'interest rate group'.

The results were striking:

  • Interest rate: 10% <> Gold: -8%
  • Interest rate: 8% <> Gold: -3%
  • Interest rate: 6% <> Gold: +2%
  • Interest rate: 4% <> Gold: +7%
  • Interest rate: 2% <> Gold: +12%
  • Interest rate: 0% <> Gold: +17%
  • Interest rate: -2% <> Gold: +22%

As you might expect, these are real interest rates; interest rates corrected for inflation (which could easily be negative).

But on the basis of historical prices, we can imagine that the returns on gold may turn out to be even higher than the current average of 10%.

Conclusion

In short: low interest rates, higher gold price. Old-fashioned gold is an effective alternative investment in times like these. And an investment isn’t going to become much safer than gold: it has a track record spanning more than 6000 years and cannot go bankrupt (which doesn’t hold for banks, businesses and countries). And if real interest rates rise (and debts are written off), we will come up with something new. Right?

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