©Gibson's Gold Law

Gibson's Paradox - Revisited


Chris Gilbert Waltzek

November 29, 2012

While 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.

Subsequent 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.

If 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.

How 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%.

Next, 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 gold price.

Maintaining 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:

Figure 1.1. Gibsons Gold Law - Back-test:

2001: $300;
2002: $360;
2003: $432;
2004: $518;
2005: $622;
2006: $747;
2007: $895;
2008: $1074;
2009: $1289;
2010: $1547;
2011: $1857.

Do 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, 2011):

Figure 1.2. Gibsons Gold Law - Forecast:

2012: $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.

Therefore, 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. The Alpha Stocks Newsletter includes this article and many others which are dynamically updated, regularly. If you'd like the weekly market analysis and portfolio of stock candidates, the monthly cost is less than $1 per day; most subscribers prefer the annual $147 fee due to the cost savings:

Alpha Gold Stocks

Tops the XAU/GDX +27%

Click Below:

 

References

Keynes, J., M. (1930). A Treatise on Money. Macmillan.

ISBN 0-404-15000-4.

White, S. (2011). Gold poised for upside breakout of current range. Retrieved from

http://www.hindecapital.com/blog/gold-poised-for-upside-breakout-of-current-range/

Summers, L., & Barsky, R. (1988). Gibson's Paradox and the gold standard.

The Journal of Political Economy, 96(3), 528-550. Retrieved from

http://www.gata.org/files/gibson.pdf
 

 

 


 

PLEASE READ CAREFULLY - Disclaimer: Information provided must not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author / editor of this web site has not been paid by any company or service to promote the stock picks. All stocks are chosen entirely due to technical / fundamental characteristics. Any action taken as a result of information, analysis, or advertisement is ultimately your responsibility. The host and author is not a paid adviser. Investing in high alpha stocks involves substantial risk. Past performance is no guarantee of future returns. Consult your investment adviser before making any investment decisions. Investors are advised to apply only a fraction of their total portfolio, less than 2% to the total of all picks. Only RISK CAPITAL should be used due to the high volatility associated with such investments. None of the stock information, data and company information presented herein constitutes a recommendation or a solicitation of any offer to buy or sell any securities. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. Individual stocks presented may not be ideal to your investing objectives. Although information has been obtained from and is based upon sources believed to be reliable, we do not guarantee its accuracy and the information may be incomplete or condensed. All opinions and estimates constitute judgments contingent upon the date of the report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a investment security. Past performance is no indication of future results.


 

 

©Gold Seek LLC