Bill Gross Criticizes Federal Reserve For Negative Real Rates

Bill Gross is far from being a goldbug, but his complaint makes for gold's opportunity. As excerpted by GoldAlert, Gross had some harsh words for the Federal Reserve's negative real interest rate policy:

With QE helping to push real interest rates into negative territory, Gross noted that “perhaps the most deceptive policy tool to lessen debt loads is the ‘negative’ or exceedingly low real interest rate that central banks impose on savers and debt holders.”

Gross went on to say that “to rebalance debt loads and re-equitize financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders and giving it to another. A low or negative real interest rate for an “extended period of time” is the most devilish of all policy tools…To put it bluntly, they (central banks) are robbing savers and taking money surreptitiously from longer-term asset holders who are incorrectly measuring future inflation.”

While Gross focused on the impact of the Fed’s policies on bonds, the investment implications for the gold price are quite favorable. The PIMCO fund manager did not provide a specific time frame, but his commentary suggests that he expects negative real interest rates to remain for the foreseeable future.

That point about "incorrectly measuring future inflation" does explain why the bond vigilates seem to be ghosts from the past. Negative real interest rates do imply that debtholders, as a class, have misestimated inflation on the low side. That underestimation could be the result of some big holders, like the People's Republic of China, not caring all that much about real interest rates. It could be the inflation-is-licked assumption mutating into the deflationist meme. It could be the international prestige the U.S. enjoys, whether rated or not. Whatever the reason, it's a fact that inflation rates have been underestimated by the Treasury debt markets. Gross' expectation for continued negative real rates implies that bond buyers will continue to do so.

The real rate is an important fundamental for bonds, particularly long-term ones. The average real rate is about 3%. Thus, bonds are undervalued when the real rate is well above 3% (as they were in the 1980s) and overvalued when the real rate is substantially less than 3% (the 1970s.) Although long-term bonds aren't that overvalued right now, using conventional inflation figures, short-term bonds and bills definitely are and have been for some time now. There is a case to be made for a Treasury securities bubble being in place.

Inflation overoptimism, contrasted with a more pessimistic take on the inflation problem in the gold market: that explains the otherwise puzzing concurrency of bull markets in both. Those opinions diverging so markedly suggests one group is going to be revising theirs eventually. Given the bond market's record of errors, my guess would be the bond market - ushering in a new bear for debt instruments. That would put the squeeze on the U.S. government budget, perhaps a hard one. Despite gold's enviable performance over the last decade, it's the bond bull that's longer in the tooth and more vulnerable to reversal.

At any rate, as GoldAlert noted, negative real interest rates are good for gold because its negative carry is less onerous when debt instruments become "certificates of guaranteed confiscation." Negative real rates serve as a good metric for whether or not gold will keep rising: as of now, they say "yes."