Sep 29, 2018

Gold and the prospect of higher interest rates

Gold and the prospect of higher interest rates

The US trend toward restricting the supply of money has investors scratching their heads on what higher interest rates signals.

Investopedia looks at the effects of monetary policy on the gold price.

Despite widespread popular belief of a strong negative correlation between interest rates and the price of gold , a long-term review of the respective paths and trends of interest rates and gold prices reveals that no such relationship actually exists.

The correlation between interest rates and the price of gold over the past half century, from 1970 to 2015, has only been about 28%, which is considered to be not much of a significant correlation at all.

A study of the massive bull market in gold that occurred during the 1970s reveals that gold’s run-up to its all-time high price of the 20th century happened right when interest rates were high and rapidly rising.

Short-term interest rates, as reflected by one-year Treasury bills (T-bills), bottomed out at 3.5% in 1971. By 1980, that same interest rate had more than quadrupled, rising as high as 16%.

Over that same time span, the price of gold mushroomed from $50 an ounce to a previously unimaginable price of $850 an ounce. Overall during that time period, gold prices actually had a strong positive correlation with interest rates, rising right in concert with them.

A more detailed examination only supports the at least temporary positive correlation during that time period further. Gold made the initial part of its steep move up in 1973 and 1974, a time when the federal funds rate was rising quickly.

Gold prices fell off a bit in 1975 and 1976, right along with falling interest rates, only to begin soaring higher again in 1978 when interest rates began another sharp climb upward.

The protracted bear market in gold that followed, beginning in the 1980s, occurred during a time span when interest rates were steadily declining.

During the most recent bull market in gold in the 2000s, interest rates declined significantly overall as gold prices rose. However, there is still little evidence of a direct, sustained correlation between rising rates and falling gold prices or declining rates and rising gold prices, because gold prices peaked well in advance of the most severe decline in interest rates.

While interest rates have been kept pressed to nearly zero, the price of gold has corrected downward. By the conventional market theory on gold and interest rates, gold prices should have continued to soar since the 2008 financial crisis.

Also, even when the federal funds rate climbed from 1 to 5% between 2004 and 2006, gold continued to advance, increasing in value an impressive 49%.

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