{"id":55535,"date":"2014-08-06T07:23:28","date_gmt":"2014-08-06T11:23:28","guid":{"rendered":"http:\/\/countingpips.com\/?p=55535"},"modified":"2014-08-06T07:23:28","modified_gmt":"2014-08-06T11:23:28","slug":"gold-investors-shouldnt-fear-rising-interest-rates-heres-why","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2014\/08\/gold-investors-shouldnt-fear-rising-interest-rates-heres-why\/","title":{"rendered":"Gold Investors Shouldn\u2019t Fear Rising Interest Rates: Here\u2019s Why"},"content":{"rendered":"<div id=\"inves-588385466\" class=\"inves-below-title-posts inves-entity-placement\"><div id =\"posts_date_custom\"><div align=\"left\">August 6, 2014<\/div><hr style=\"border: none; border-bottom: 3px solid black;\">\r\n<\/div><\/div><div class=\"post-content\">\n<p><strong>By <a href=\"http:\/\/goldstockbull.com\/\" target=\"_blank\">GoldStockBull.com<\/a><\/strong><\/p>\n<p>Investors commonly assume that rising interest rates adversely impact the gold price, and vise versa. \u00a0They believe that a rising interest rate environment is indicative of a strong economy, which is supposed to drive investors out of gold and into the stock market. \u00a0They further assume that investors will want to exchange their gold, which has no yield, for stocks and bonds, both of which have yields and generate income.<\/p>\n<p>But this intuition is unfounded, at least when tracking the Fed Funds Rate since the Nixon abandoned the gold standard\u00a0(i.e. after August 15th, 1971). Since then, a rising Fed\u00a0Funds Rate\u00a0has usually coincided with rising gold prices, and vise versa.<\/p>\n<p>Consider the following data (gold price data is from Kitco, Fed Funds Rate data is from the St. Louis Fed):<\/p>\n<ul>\n<li>From August 1971 through December 1974 the gold price rose from $35 to $200 per ounce, while the effective Fed Funds Rate rose from 5.5% to 8.5%.<\/li>\n<li>From January 1975 through August 1976 the gold price dropped to just over $100\/oz, while the Fed Funds Rate fell to 5.25%.<\/li>\n<li>In January of 1980 the gold price peaked at over $800\/oz while the Fed Funds Rate rose to 14%.<\/li>\n<li>The gold price then fell to about $290\/oz in late February, 1985, while the Fed Funds Rate fell to 8.6%.<\/li>\n<li>The pattern breaks here as the gold price rose to $500 in December, 1987 while the Fed Funds Rate continued to fall to 6.8%.<\/li>\n<li>However the trend continues as the gold price fell to $330 in March, 1993 while the Fed Funds Rate fell to 3%.<\/li>\n<li>The gold price then rose to $415 in February, 1996 while the Fed Funds Rate rose \u00a0to 5.2%.<\/li>\n<li>The gold price then fell until hitting its September, 1999 bear market bottom at $255. This occurred\u00a0just before the Washington Agreement on Gold was signed, while the Fed Funds Rate remained steady.<\/li>\n<\/ul>\n<p>While the correlation is far from perfect, we can clearly see from the following charts that the Fed Funds Rate and the gold price move together more often than not and have similar trends over long time periods.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" src=\"http:\/\/static.cdn-seekingalpha.com\/uploads\/2014\/8\/4\/6546411-14071940469614694-Ben-Kramer-Miller.png\" alt=\"gold chart\" width=\"754\" height=\"486\" \/><\/p>\n<p>(Source: The Fed Funds Chart comes from <a href=\"http:\/\/www.tradingeconomics.com\/united-states\/interest-rate\">TradingEconomics.com<\/a>\u00a0and the gold price chart comes from <a href=\"http:\/\/chartsrus.com\/charts.php?image=http:\/\/www.sharelynx.com\/chartsfixed\/GC1970.gif\">ChartsRUs.com<\/a>)<\/p>\n<p>What causes this strong correlation?<\/p>\n<p>When the Fed\u00a0Funds Rate\u00a0falls this creates a carry trade that allows banks to\u00a0borrow cheap money from the Fed in order to buy assets with higher yields. \u00a0It follows that bonds and stocks\u2013or assets that have value insofar as they have a yield\u2013become more attractive by comparison. More generally,\u00a0when interest rates fall, the yield on interest-bearing assets becomes more attractive.\u00a0 A corollary of this is that assets that do not have any yield (i.e. gold and other commodities) become less attractive from an investment standpoint.<\/p>\n<p>Similarly, when the Fed Funds Rate rises this carry trade dissipates. \u00a0Banks have to pay more in order to borrow, and so they are less willing to bid up the prices of income generating assets. \u00a0As money comes out of these assets it finds a home in assets whose value is intrinsic.<\/p>\n<p>So a\u00a0bank can make money if it borrows money from the Fed at 5% to buy an asset yielding 5.5%.\u00a0 But if the Fed raises the Fed Funds Rate\u00a0to 6%, that bank suddenly has to sell the asset yielding 5.5% or else it begins to\u00a0lose\u00a0money on the trade.\u00a0Similarly, if the Fed Funds Rate drops to 4%, the bank has incentive to hold the asset even if it rises in value while its yield falls.<\/p>\n<p>Ultimately we can conclude that a high interest rate should indicate to investors that they should sell their gold, but a rising interest rate is a tailwind that will drive the gold price higher.\u00a0 Similarly a low interest rate is an indication that investors should buy gold, whereas a declining\u00a0interest rate acts as a headwind.\u00a0 It follows that <strong>the best time to buy gold is when rates are low, but set to move higher, and the best time to sell gold is when rates are high but set to move lower.<\/strong><\/p>\n<p>With the Fed Funds Rate at 0.1%, it is evident that gold is positioned to move substantially higher. \u00a0Low interest rates are forcing investors into stocks and bonds for now as they reach for yield, but this is generating a bubble in paper assets and an \u201canti-bubble\u201d in gold and other\u00a0commodities. \u00a0But interest rates cannot stay low forever. While\u00a0the Fed\u2019s low interest rate policy is\u00a0pushing stock and bond prices higher, it is also\u00a0infusing potential energy into the gold market.<\/p>\n<p>Therefore, it\u00a0is only a matter of \u201cWhen?\u201d and not \u201cIf?\u201d this trend reverses and gold catapults higher.<\/p>\n<\/div>\n<p><span class=\"fn\">By <a title=\"Posts by Ben Kramer-Miller for Gold Stock Bull\" href=\"http:\/\/www.goldstockbull.com\/articles\/author\/benkm\/\" rel=\"author\">Ben Kramer-Miller for Gold Stock Bull<\/a><\/span><\/p>\n<p>&nbsp;<\/p>\n<p>&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>By GoldStockBull.com Investors commonly assume that rising interest rates adversely impact the gold price, and vise versa. \u00a0They believe that a rising interest rate environment is indicative of a strong economy, which is supposed to drive investors out of gold and into the stock market. \u00a0They further assume that investors will want to exchange their [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-55535","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/55535","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=55535"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/55535\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=55535"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=55535"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=55535"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}