Gold and silver prices go up and down for many reasons. We've talked in the past about the kinds of things that increase silver prices. But what about gold, and more specifically, what kind of interest rate environment causes gold prices to go up? Does gold go up when interest rates rise? Is there a cause-effect relationship, or are there other micro- and macro- forces at play? How can we even tell? Ask around and the most common answer to does gold go up when interest rates rise is no...
And yet, common answers are so often misleading.
Common sense and logic propose that when times are bad, people buy gold. Few people wouldn't want a safety net against a declining dollar.
Gold bullion bars, for example, are often purchased to hedge against assets that perform badly during economic downturns. During these downturns, interests rates are often held low by means of fiscal and monetary policies. For example, low interest rates allowed for cheap credit that helped the United States recover from the 2008 great recession.
Gold's value, however, is only revealed in a falling economy because its value isn’t dependent on economic activity. It is money pure and simple. Cash, property, stocks, and other assets valued in dollars, however, naturally decrease in value.
Historically, investors have flocked to gold during economic strife causing its value to rocket. Logically analyzing this situation reveals a problem: higher interest rates means the opportunity cost of holding gold is higher.
In other words, your money will earn more elsewhere. So what's there to do? Like many people, you might move away from gold and back to these assets when the interest rate rises.
After all, interest rate hikes are an indicator of an improving economy. Savings accounts pay more interest, people say, and shares pay higher dividends, and property values will rise faster, and so on. That's not the whole picture, though. Smart investors know that high interest rates (as in many underdeveloped countries) only mean higher risk profiles.
So is there less incentive to hold gold? After all, it pays no interest at a time when other assets are paying big rewards... This could not be further from the truth. In fact, rising interest rates are often a market response to fears of economic instability and currency volatility.
Economic studies suggest that there is little obvious correlation between interest rate hikes and the price of gold. A few detailed studies exhibit evidence gold prices in-fact rising, however, this is a hard call to make. Research published by Goldmoney suggests that gold increasing 4.85% during interest-rate hiking cycles. That is in comparison to 4.0% during interest-rate cutting cycles.
A study from HSBC shows quite clearly that the price of gold increased after the last four Fed rate hikes. Still, take this with a time-adjusted grain of salt. It may be evidence of a long-term price increase in gold due to other factors such as an ever weakening greenback. So having debunked what conventional wisdom tells you about gold hikes and interest rates, is there a better source? Look at history.
There is a view that gold prices will fluctuate solely based on economic ups and downs. To a large degree, history supports precious metals as counter-cyclical to the economy. Yet, neither the economy not precious metals ought to be judged primarily by interest rates. It is essential to look deeper beyond the numbers. What if, for example, interest rates remained lower than inflation for a prolonged period?
This common occurrence would still mean holding cash in a savings account would still be a loser’s game, and holding onto gold would appeal. Gold does even better when real interest rates are negative. Take into account, however, that in 2017 the price of gold remained relatively stab;e banks were paying negative interest rates. What at first might seem strange in-fact reflects market opportunities.
That's why history teaches us to look at fundamentals whether you want to buy a Comex Futures contract or buy a 1 ounce gold coin cheap. When a government pays an inflation-beating interest rate, there’s less reason to hedge against traditional assets, but don't let this cloud the big picture for you. There are so many other factors to consider.
Even though gold doesn’t pay interest, there is still room for capital gains in a healthy economy. The statistics prove it. Demand for gold might rise due to rate hikes being bearish for stocks. Demand for precious metals from industrial buyers would likely grow during a growing economy too. The supply of gold, although as important as demand for buyers, will still have an impact on the overall price.
While at first glance odd, the phenomenon of rising gold prices during a period of rising interest rates may very well occur during a classic depression. Are we headed for one? The economy improved significantly during Donald Trump’s first year in office, and shows no self-evident signs of impending disaster. Yet, the prospect of rate rises has kept many investors with gold as part of their diversified portfolio. Sure, gold and silver prices fluctuate every day, and some investors may be short-term oriented, but there is always more wisdom in long-term plays.
In the very long-term, gold has reliably risen more or less in line with inflation, so you shouldn’t be too put off if you’re in it for the long run. And that's what we should expect. The future of metal markets can’t be predicted, but the more you know about everything affecting gold prices, the better off you are.