Last week’s yield curve recession indicator article proved popular with readers, so here’s more on interest rates and gold. Specifically answering the question: If interest rates rise, what happens to gold prices?
This post covers:
- A common misconception about gold and rising interest rates
- Rising interest rates in the 1970’s and the effect on gold
- How the last 6 Federal Reserve Interest rate hikes have impacted the gold price
- What might the future hold for interest rates and gold?
A Common Misconception About Gold and Rising Interest Rates
Last week the Federal Reserve raised their Fed Funds rate another 0.25% to 1.75%. Common wisdom says that gold should fall when interest rates rise. You will see that sentiment in headlines like this from CNBC last month:
Where they also explained: “Higher interest rates make gold a less attractive investment because it 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
Let’s look back at the 1970’s now. In particular the latter half of that decade when interest rates were steadily rising.
The below chart clearly shows gold rising with interest rates from 1976 to the end of the decade.
Why Does Gold Rise When Interest Rates Rise?
Gold has a cost of carry. This simply means as 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.
How Have the Last 6 Federal Reserve Interest Rate Hikes Affected the Gold Price?
How has gold performed following the Fed rate hikes of the past couple of years?
In 5 of the last 6 rate hikes gold has turned higher straight after the fed announcement. The only time it didn’t was in June of last year. But then gold bottomed out a few weeks later and turned higher.
Gold is clearly rising with current interest rates increases.
What Might the Future Hold for Interest Rates and Gold?
The last Fed rate hike a week ago also saw gold bottom out and turn immediately higher. Gold has been making higher lows and then higher highs following each rate hike.
If this pattern continues then the US$1375 high from 2016 may soon be breached as gold moves higher again. Be sure to have your position in gold before this next run higher begins. Buy gold or buy silver.
Or for help deciding what type of gold to buy see: PAMP Suisse Gold / Silver vs Local NZ Gold / Silver: Which should I buy?
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