Negative Real Interest Rates

Negative real interest rates are the product of aggressive monetary policy by a central bank and have a profound impact on the movement of capital within an economy and the valuations on the stock market

To calculate the real interest rate, you simply take the nominal rate of interest and subtract the current inflation rate to deduce the real rate.  Therefore, if the cost of borrowing, or interest, is 3% per year, and inflation is 4%, it is said that negative real rates now exist since the real rate is effectively -1% interest.

Negative Real Interest Rates and Stocks

Negative real rates are particularly beneficial for the stock market, since companies can borrow practically free money and invest and grow their businesses.  The companies that make the most use of nearly free money are usually those who prosper most, since negative real rates are most commonly introduced by central bank action at the height of an economic recession.

However, even the most prudent companies can take advantage of negative real interest rates.  Nearly every company has some kind of debt, whether short term accounts payable or long term corporate bond obligations.  Negative real rates allow a company to refinance their debt and reduce their overall interest expenses for years in the future, even if the negative real interest rates are only temporary.  Negative real rates help boost bottom line profits, which is always welcomed by the stock market. 

Negative Real Rates and Gold

Negative real rates and gold share a strong correlation, wherein gold surges each time negative real interest rates are present.  Gold is seen as a barometer and hedge against inflation, and therefore, when the cost of borrowing is below the inflation rate, it is usually profitable to borrow and buy gold.

Because of this phenomenon, negative real rates and gold tend to rise together. When the negative real rates are further negative, gold surges higher.  When the negative real rates fall to reach zero, gold starts to ebb as well. 

While negative real rates and gold share the strongest correlation, negative real interest rates are just as bullish for any other commodity, including food commodities, other precious metals, and energy.

Front Running Negative Real Rates

Front running negative real rates is the goal of any short term commodity or stock trader.  If it is possible to move into the market before other investors realize the negative rate potential, there is an opportunity for excessive profits.

The most important indicator to watch is the Federal Reserve's discount rate, or the rate at which the institution loans to member banks.  When the Fed is on a cutting spree and has been pushing rates down significantly and consistently, it is generally a very good time to make short term investments in highly indebted companies (who can then reduce borrowing costs) and commodities (the correlation between negative real rates and gold is strongest).

This play has, and will continue to be, an extremely profitable market phenomenon.  Traders who can sense future monetary policy decisions will make more than they could ever imagine.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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