It is often erroneously believed that rising interest rates lead to lower gold and silver prices because precious metals do not pay interest. But when we review periods of higher nominal interest rates, as is being discussed today, a different pattern emerges. Precious metals do not pay interest. That part is true. But when nominal rates tighten, the capital gains from owning precious metals far exceed the gains experienced from interest rate increases alone. Some of the most explosive gains of the century have occurred during and following periods of high inflation and rising interest rates, such as we see happening now. Today, we will look at similar previous periods and the implications for precious metals moving forward from here.

Some examples of past interest rate increases and corresponding moves in the gold price might be enlightening. Between late 2015 and early 2019, the Federal Reserve raised interest rates from near zero to 2.4%, a 17-fold increase in rates. Gold increased 24% over that period. It would take nearly ten years to earn that amount of interest at 2.4%, but it would not have been possible, as rates came down to near zero shortly after that. For perspective, a 24% rally in gold today would be $2,294 per ounce.

Between 2004 and 2006, Federal Reserve Chairman Ben Bernanke consistently raised the Federal Funds Rate from under 2% to over 5%. Interest rates nearly tripled during that period. What happened to someone holding physical gold as this was happening? Gold increased 75% in price. A similar move today would put gold in the range of $3,200 per ounce. For perspective, it would take nearly 12 years of compounding 5% earnings to equal this 2-year capital gain in the gold price.

Moving back a little further in time, we can look at inflationary and stagflationary periods from different eras and see if the effects were similar. This is perhaps more indicative of what might be possible moving forward, as the conditions more closely match what we are seeing in the world today. From 1972-74, the Federal Fund Rate was increased from 3.3% to 13%, a nearly fourfold increase. Gold went on a tear, rising 300% over the same period. While 13% sounds like an incredible amount of interest to earn compared to where interest rates are today, it would still take over eight years of compounding earnings to equal 300%. Today, a similar move would put gold in the $5,500/ounce range.

The grandaddy of past stagflationary periods accompanied by rising interest rates occurred between 1977 and 1980 when interest rates were throttled upward from 4.5% to 20%. The steepest moves came during the reign of Federal Reserve Chairman Paul Volcker, who is famously credited with dealing a death blow to inflation by raising interest rates higher than most people thought possible at the time. Amazingly and counter to the narrative that rising interest rates are a death knell for precious metals, gold went up 550% during the same period. Today, a similar move for gold would put the spot price over $10,000 per ounce. Unfortunately for those depending on high interest rates, they were cut in half a few months later.

With many waiting for an announcement from the Federal Reserve today about possible interest rate policy changes, no formal announcement has been made. St. Louis FED Governor James Bullard released a statement saying he believes the pace of interest rate increases should be increased, reaching 1% by July from near zero (0.08%) today. But his recommendations are only one of many to be considered by FED Chairman Pro Tempore Jerome Powell. Chairman Powell’s term expired last weekend, and his renomination has not yet been confirmed. As such, there is some degree of uncertainty as to the timing and direction of FED policy, and exactly who will implement it in the coming months. But for the purpose of determining future gold prices, it doesn’t matter that much.

We have made the case before that we are unlikely to see interest rates increase to the levels seen during the Volcker era in the 1970’s and 80’s. There is too much debt to sustain interest rates that high today. But in the end, it doesn’t matter. The underlying inflation and negative real interest rates make the difference for gold, not the level of nominal interest rate increases we may or may not see. With negative real rates at (-)7%, gold has plenty of opportunities to outperform. We earlier made the case that higher energy prices are being used to try and tame inflation this time rather than higher interest rates alone. A higher level of indebtedness is also a factor since higher balances equate to higher payments, even when interest rates are historically low.

I delayed finishing this article, waiting to hear the results of what many claimed was an emergency meeting of the Federal Reserve today (Monday). So far, the only announcements have been from St Louis FED President James Bullard shared his opinion, which we discussed earlier. Nothing concrete has been revealed, and it appears that consensus is lacking among the FED Governors and FED Chair Pro Tempore Powell about how much and how soon interest rates will be increased. We can assume from the lack of action and clear direction given that the Federal Reserve much prefers inflation to deflation. While deflation can temporarily help the public save money on future purchases of items going down in price, it is the bane of governments everywhere. In the end, it only increases the uncertainty about how long inflation will last, and how high it will go.

When assets drop in value (deflation), higher default rates on loans are used to purchase those assets. It also leads to capital losses when the assets (such as real estate or stocks) are sold. Losses cannot be taxed, but gains can be. Even when gains are disguised as inflation, they can still lead to higher tax revenues without higher tax rates. So government policies will almost always favor inflation rather than deflation. Whatever the action Federal Reserve ultimately takes, it will likely be insufficient to halt inflation quickly and too short-lived to allow an enduring deflationary scenario. If history is any guide, gold and silver can help keep us solvent and move forward financially while these things are sorted out.