Upsetting the Fed Rate Hike–Gold Price Negative Correlation Theory
Investors have generally held on to the belief that rising Fed rates would be bearish for gold prices. But is there are sound basis for that theory?
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In online stock trading you often need to gun down your preconceptions and misconceptions. But what about common opinions held by most of the investors? They need not always be right, and in such circumstances you only need to apply a bit of logic and tons of historical perspective. Negative Correlation between Fed Rates and Gold? How do Fed interest rate hikes affect gold, or do they ever affect the precious metal? The general consensus leads us to believe that hikes in interest rates result in gold prices going down. But Investopedia’s JB Maverick believes that it isn’t really known whether gold prices and interest rates have any kind of correlation. It could even be that the rising interest rates could have the opposite effect on prices of gold – make them rise. Investors are of the belief that with the Federal Reserve normalizing interest rates gradually, the gold prices will be pressured downward. According to many market analysts and investors, rising rates of interest could result in fixedincome investments appearing more attractive. They believe the money will flow out of gold and into investments with higher yields such as money market funds and bonds. Historical Review Doesn’t Support any Consistent Negative Correlation Maverick points out that in spite of the idea that there is a negative correlation between rising rates of interest and gold prices, historical review doesn’t reveal any such relationship. Right from 1970, the correlation between the rates of interest and gold prices has actually been only in the region of 28%. And that isn’t a major correlation, by any stretch of the imagination. The Gold Bull Run of the 1970s Gold experienced a bull market run in the 1970s. At that time, gold headed to 20th century’s all-time high. Simultaneously, the interest rates were rising too. In www.tradezero.co
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1971, the short-term interest rates were scraping the floor at 3.5%. When 1980 came along, the interest rate had risen to 16%, which means that the rates had quadrupled during the 1970s. In that period, the gold price had soared from just $50 per ounce to a massive $850 per ounce. With this example it could be argued that interest rates and gold prices had a positive correlation, and a strong one at that. The only counter-argument that can be made is that this was a temporary correlation. This period was followed by a bear market for gold starting with the 1980s. And during that period, interest rates also declined steadily. The Most Recent Gold Bull Market – the 2000s Maverick points to another example, this time from the 2000s. That was when gold had its most recent bull market. That time interest rates declined simultaneously. It’s quite easy now to make the argument for a negative correlation between interest rates and gold prices. But, as the earlier example showed, there has never been a sustained correlation between a fall in gold prices and the rise in interest rates. In this example from the 2000s, gold prices actually peaked significantly ahead of the period when the interest rates declined the most. When the interest rates sunk close to zero, the gold price had actually gone through a downward correction. That wouldn’t be in line with the conventional theory of the direct connection between falling interest rates and rising gold prices. If that conventional concept was true, Maverick points out that the price of gold should have kept rising during the financial crisis of 2008. Even during the time of the federal fund rate climbing from 1% to 5% from 2004 to 2006, gold managed to keep advancing. There was a significant 49% rise in value.
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The Law of Supply and Demand Applies for Gold Too Maverick concludes that gold prices are affected not by interest rates but ultimately the law of supply and demand, with demand being the stronger component. It is important to remember that a gold deposit needs around 10 years for it to be made a productive mine. That means the gold supply level changes only gradually. Maverick argues that higher rates of interest could be beneficial for gold prices since they usually are bearish for stocks.
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