Gold and Interest Rates: What You Need to Know

As Monday’s blog pointed out, gold bugs are currently juggling multiple economic and geopolitical indicators that are affecting the gold price, one of them being U.S. interest rates. The Federal Reserve is meeting on Tuesday-Wednesday of this week and is expected to announce a raise in short-term interest rates, which have been at near-zero levels since December 2008. Interest rates affect many markets, whether it be stocks, bonds, mutual funds, currencies, etc. Their relationship with gold, however, is more complex and controversial. Below we have laid out what we believe gold buyers should know about the relationship between gold and interest rates.

Gold and Interest Rates: Popular Opinion

There is a popular notion that high interest rates are bad for gold prices. Adam Hamilton explains the logic behind this assumption in his Seeking Alpha blog titled Gold Actually Thrives In Rising-Rate Environments:

“The underlying logic is simple. When interest rates rise, so do yields on bonds and cash in the form of money-market funds. This makes bonds and cash relatively more attractive to investors than gold, which yields nothing. Therefore they jettison their gold holdings to migrate capital back into bonds and cash.”

In other words, higher interest rates mean higher profits on interest-bearing investments such as bonds, CDs, and money market funds. Gold and other precious metals are not interest-bearing, so higher interest rates shift money over to the stock market and away from gold. But has this been true in the past? Is there any statistical evidence for this claim?

Gold has thrived in the past during times of high interest rates

Hamilton argues that historical data goes against the popular opinion that high interest rates are bearish for gold, pointing out that gold has been bullish during times of high and rising interest rates and vice versa. For example, during the late 1970s, gold surged at the same time interest rates were rising. In addition, gold slumped in the 1990s while interest rates were falling. He estimates that “only 28% and 26% of gold’s daily price action over the last 45 years was mathematically explainable by changing interest rates.” He compiled the chart below to illustrate his claim:

As the chart shows, the relationship is not so clear-cut and there are many other factors to consider. In his opinion, interest rates “are a minor secondary gold driver at best,” and “Interest rates’ impact on gold prices is far more indirect and nuanced than the simplistic up-is-bearish interpretation popular today.”

Higher interest rates can hurt the stock market

Gold and other precious metals have long been considered an “alternative investment” to traditional ones such as stocks, bonds, and other cash-based assets. When stocks and bonds are doing well, investors tend to stay put and continue reaping profits. But when the markets take a downturn, investors look for an alternative, often turning to hard assets such as physical gold. High interest rates tend to increase yields on bonds, which are longer-term and lower-risk investments. For those seeking a profit, this makes bonds more attractive than stocks, so the stock market suffers and appears more overvalued. And when the stock market suffers, many investors move their money into gold. This occurred in the 1970s, as Hamilton describes:

“So investors looked for alternatives, and flooded into gold. Their buying blasted it up 186.4% in 1973 and 1974 while short rates were surging and long rates were rising! Even though 1-year and 10-year Treasury yields averaged jaw-dropping by today’s standards levels of 7.8% and 7.2% over those couple years in the mid-1970s, investors still didn’t hide out in cash or pour vast sums into bonds. They wanted gold.”

Therefore, higher interest rates do not necessarily spell out bad news for gold – on the contrary, they can even be good for gold.

In Conclusion

Past performance is not indicative of future results, and popular opinions based on fundamental analysis are often contradicted in the markets. With the next Fed meeting nearing completion, it is easy to get wrapped up in the hype around interest rates and the effect they may have on gold this time around, but keep in mind that it is nothing more than speculation. No one can predict the future for any asset, and there is nothing wrong with this fact since gold’s primary purpose is to serve as long-term financial security. To learn more about the benefits of owning gold and how you can add it to your retirement portfolio, call American Bullion at 1-800-326-9598 to speak with an agent about opening a Gold IRA.