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The Effect of Fed Fund Rate Hikes on Gold

Nov 27, 2018 | Investopedia |

The Effect of Fed Fund Rate Hikes on Gold

Written by J.B. Maverick via Investopedia

As the Federal Reserve continues to slowly normalize interest rates, many investors believe that higher interest rates will pressure gold prices downward. Many investors and market analysts believe that, as rising interest rates make bonds and other fixed-income investments more attractive, money will flow into higher-yielding investments, such as bonds and money market funds, and out of gold, which offers no yield at all.

The Historical Truth

Despite the widespread popular belief of a strong negative correlation between interest rates and the price of gold, a long-term review of the respective paths and trends of interest rates and gold prices reveals that no such relationship actually exists. The correlation between interest rates and the price of gold over the past half-century, from 1970 to present, has only been about 28%, which is not considered to be much of a significant correlation at all.

A study of the massive bull market in gold that occurred during the 1970s reveals that gold’s run-up to its all-time high price of the 20th century happened right when interest rates were high and rapidly rising. Short-term interest rates, as reflected by one-year Treasury bills (T-bills), bottomed out at 3.5% in 1971. By 1980, that same interest rate had more than quadrupled, rising as high as 16%. Over that same time span, the price of gold mushroomed from $50 an ounce to a previously unimaginable price of $850 an ounce. Overall during that time period, gold prices actually had a strong positive correlation with interest rates, rising right in concert with them.

A more detailed examination only supports the at least temporary positive correlation during that time period further. Gold made the initial part of its steep move up in 1973 and 1974, a time when the federal funds rate was rising quickly. Gold prices fell off a bit in 1975 and 1976, right along with falling interest rates, only to begin soaring higher again in 1978 when interest rates began another sharp climb upward.

The protracted bear market in gold that followed, beginning in the 1980s, occurred during a time span when interest rates were steadily declining.

During the most recent bull market in gold in the 2000s, interest rates declined significantly overall as gold prices rose. However, there is still little evidence of a direct, sustained correlation between rising rates and falling gold prices or declining rates and rising gold prices, because gold prices peaked well in advance of the most severe decline in interest rates.

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