What Is the Effect of Rising Interest Rates on Gold Prices?
October 19, 2018 88 view(s)
Concerns investors had last week regarding the Fed’s ultimate decision on potentially raising rates at the end of this year have been cemented as of Wednesday after the Federal Reserve released meeting minutes showing broad agreement on the need to raise borrowing costs. Fear of rising rates helped give way to a major sell-off last week resulting in the Dow dropping over 1,300 points in a single day. Although there are multiple concerns regarding volatility in the market weighing on investors’ minds, the Fed seems definitive in its decision to keep raising interest rates. What could this mean for Gold prices in the near future? Could rising interest rates have a bullish effect on gold prices? Despite President Donald Trump’s view that interest rate hikes have already gone too far, the Federal Reserve seems adamant about raising rates as every Fed policymaker backed the central bank’s September decision to raise the target policy rate to somewhere between 2 percent and 2.25 percent, according to the minutes of the September 25-26 meeting, which were published Wednesday. In August, Trump said he was “not thrilled” with Fed Chair Jerome Powell for raising interest rates, and has since escalated his criticism, saying the central bank is his “biggest threat.” Today the Dow fell nearly 100 points, or about 36 percent, once the minutes of the meeting at the Fed were released. The S&P 500 fluctuated between positive and negative territory once the minutes showed that policymakers were united in anticipation that further increases would be made on interest rates. “This is consistent with the Fed’s rhetoric that they will continue to gradually raise interest rates. A lot has to happen for the Fed not to move again in December,” said Ryan Sweet, head of monetary policy research at Moody’s Analytics. Some strategists even claim that traders used the minutes released today as a reason to change direction. Before the minutes’ release, trading had already been relatively choppy. As of Wednesday, US equities had only partially recovered ground lost in the massive sell-off as of last week; the market suffered its biggest loss since March. US stocks fell on Thursday as weak earnings reports from industrials raised worries about rising expenses and the impact of tariffs, adding to concerns over higher borrowing costs. Declining issues outnumbered advancing once on the New York Stock Exchange by a 2.16-to-1 ratio; on Nasdaq, a 2.47-to-1 ratio favored decliners as well as of Thursday. The S&P recorded 18 52-week lows while the Nasdaq recorded 61 new lows. And despite the popular belief of a strong negative correlation between interest rates and the price of gold, a long-term review of the history and trends of rates and gold prices reveals that no such relationship actually exists. A study of the massive 1970s bull market in gold reveals that gold’s path to its all-time high price of the 20th century happened right when interest rates were high and rapidly rising. Short-term interest rates bottomed out at 3.5 percent in 1971 and by 1980, that same interest rate had more than quadrupled, rising as high as 16 percent. The price of gold ballooned from $50 an ounce to $850 an ounce in the same time span. Even when the federal funds rate climbed from 1 to 5 percent between 2004 and 2006, gold continued to advance, increasing in value at 49 percent. In fact, rising and higher interest rates may be bullish for gold prices, simply because they are typically bearish for stocks. It is the stock market, rather than the gold market, that typically suffers the largest outflow of investment capital when rising interest rates make fixed-income investments more attractive. Higher rates mean increased financing expenses for companies, an expense that usually has a direct negative impact on net profit margins. That fact only makes it more likely that rising rates will result in devaluations of stocks. And whenever the stock market declines significantly, one of the first alternative investments that investors consider transferring money into is gold. Within that past week, we have already seen many investors jumping at the opportunity to buy gold as rates are due to increase amidst massive sell-offs on Wall Street. Not only are those fears coming to fruition with the Fed’s decision to more than likely raise interest rates once again at the end of this year, but the global markets are facing great volatility at home and abroad; in Europe, between Western powers and Saudi Arabia, stalled Brexit negotiations, and an ongoing US trade war with China, Given the historical tendencies of stock market prices and gold price reacting to rising interest rates, it is far more likely that stock prices will be negatively impacted by rising interest rates and that gold may actually benefit as a safer alternative investment.