Last week the Reserve Bank of New Zealand raised the Official Cash Rate for the first time in 7 years. Today we look at interest rates and gold. Specifically answering the question: If interest rates rise, what happens to gold prices? This post covers:
Table of Contents
- A Common Misconception About Gold and Rising Interest Rates
- Rising Interest Rates in the 1970’s and the Effect on Gold
- Why Does Gold Rise When Interest Rates Rise?
- What Happened to the Gold Price the Last Time the Federal Reserve Hiked Interest Rates?
- What Might the Future Hold for Interest Rates and Gold?
Estimated reading time: 6 minutes
A Common Misconception About Gold and Rising Interest Rates
Last week the New Zealand central bank raised the OCR by 0.25% to 0.50%. Common wisdom says that gold should fall when interest rates rise. You will see that sentiment in headlines like this from CNBC last month: Gold falls 1% on rise in yields, early Fed rate hike fears. Where they also explained: “A Fed rate hike would increase the opportunity cost of holding gold, which pays no interest.” But how does this common wisdom stack up with reality?
What Really Happens to Gold When the Fed Raises Rates?
Bullionvault crunched the numbers from 1986 to 2016. Looking at each time the Federal Reserve changed interest rates and how this affected gold:
- that month,
- the following month,
- 3 months later and,
- 12 months later.
30 years of numbers don’t lie. When the Fed hikes rates, gold is more likely to go up than down, across all 4 time periods. Of particular note was that 12 months after the Fed hikes interest rates, the average change in the gold price is +7.2%. That certainly confounds “common wisdom”!
Rising Interest Rates in the 1970’s and the Effect on Gold
Now let’s look back at the 1970’s. In particular, the latter half of that decade when interest rates were steadily rising. The below chart clearly shows gold (blue line) rising with interest rates (orange line), from 1976 to the end of the decade.
Why Does Gold Rise When Interest Rates Rise?
Gold has a what is known as a “cost of carry”. This simply means that because gold pays no interest, there is a cost to hold gold. There is also the opportunity cost of lost potential interest an investor could earn if their money was put to use elsewhere. That’s why the above common misconception arises, that gold falls when interest rates rise. However the rate of inflation also needs to be taken into account. This is known as the real interest rate.
Real Interest Rates and Gold
So if the inflation rate is higher than the prevailing interest rate, then the real interest rate is negative. This was the situation in the 1970’s when gold rose even when interest rates were high. Because Inflation was even higher. Looking at more recent history, gold also peaked in 2012, about the time real interest rates were at their lowest. (See the chart below. The right hand scale has the real interest rate inverted, so when the blue line is falling real interest rates are rising.) Then real interest rates rose from 2012 to 2015 while gold also fell. Since then real rates have turned up and so has gold. (Note: the chart below only goes up to 2016).
So overall we can see a very close correlation between real interest rates and gold.
This chart of our own making may be easier to follow. As the real rate of interest is not inverted. It clearly shows that gold in New Zealand Dollars moves higher when real interest rates turn lower.
For more detail on real interest rates and gold see: Real Interest Rates vs Gold Prices – What Can They Tell Us About When to Buy Gold in New Zealand? [2021 Update]
What Happened to the Gold Price the Last Time the Federal Reserve Hiked Interest Rates?
How did gold perform following the US Federal Reserve rate hikes back in 2015-2018? In 5 of the 6 rate hikes, gold turned higher straight after the fed announcement. The only time it didn’t was in June of 2017. But then gold bottomed out a few weeks later and turned higher.
So gold clearly rose with those interest rate increases.
What Might the Future Hold for Interest Rates and Gold?
Before last week’s Reserve Bank interest rate hike, the consensus seemed to be that this raise was the first of quite a few to come. We’re not so sure that is the way it will play out. Analyst Roger Kerr yesterday pointed out that the NZ dollar actually fell after last week’s rate hike:
The FX markets in marking the NZ dollar to a lower value are signalling that the performance of the NZ economy over the next 12 months is likely to be inferior to peers and competitors…
…The previous gung-ho GDP growth forecasts for the second half of 2021 and 2022 from the RBNZ, Standard & Poor’s, NZIER, Infometrics and all the bank economists are now all being hastily revised downwards as they realise that their previous forecasts were predicated on a short/sharp lockdown period and a rapid bounce back in economic activity.Source.
So the path of rising interest rates may not be as clear cut as many people believe.
However, if interest rates do rise, our guess is that so will inflation rates. The “transitory inflation” is likely to not pass through everything as quickly as the bean counters at the top expect.
Central banks are likely to err on the side of caution and raise rates too little and too late. That will mean real after inflation interest rates are likely to stay low to negative into the future. Perhaps they will get even more negative?
This is likely to be supportive for the gold price. In the medium term we will likely see a move back towards last years high of NZ$3,150.
Or for help deciding what type of gold to buy see: PAMP Suisse Gold / Silver vs Local NZ Gold / Silver: Which should I buy?
You might also want to read: The Yield Curve Recession Predictor: Impact on Gold? >> or: Everything is Awesome! But Will Gold Rise After the Latest Fed Rate Hike? >>
Editors note: This article was originally published 28 March 2018. Updated 12 October 2021.