Precious Metals and Interest Rates
Interest rates play a key role in today’s modern economy and monetary policy. The Federal Reserve can make changes to key interest rates and interest rate expectations and control the flow of capital into the economy. In other words, by maintaining low interest rates, capital is easier to acquire. This ease of acquiring capital can fuel economic growth as more money available translates into more potential spending. If too much capital becomes available, however, a situation may arise in which there is” too much money chasing too few goods.” This can lead to inflation due to the fact that as more capital looks to acquire fewer goods and services, those providers of goods and services can charge more money, hence rising prices.
Many central banks around the globe have held interest rates quite low for some time. The U.S., for example, has held rates at zero for several years now in order to spur economic growth. The U.S. is, however, getting ready to hike rates for the first time since June 2006. The topic of rising rates has been the subject of considerable discussion-and debate-and gold and precious metals have been mentioned considerably in those conversations.
Many investors seem to believe that the correlation between gold and interest rates, for example, is negative. While this does make some sense at first glance, the idea of this relationship can, in fact, be quite misleading. Looking back at gold over the last several years shows how low or negative real rates can drive the metal. Gold made its all time high back in 2011, as the Fed was engaged in a zero interest rate policy and was fighting the economic slowdown with massive amounts of bond purchases, or QE. Since that time, the metal has pulled back from this high, and currently sits around the $1200 level.
Some in the anti-gold crowd have suggested various reasons that the metal topped out when it did, such as improving economic conditions and the eventual end to the central bank’s QE program.
Many also suggest various arguments against holding gold, such as the fact that gold incurs storage costs and “does nothing” in terms of dividends or interest earnings. There is also the argument that gold will not perform well when interest rates do start to rise…
In Reality, however, gold can potentially perform well in both declining and increasing rate environments.
One of the major reasons for this possibility is the fact that as interest rates rise, there may potentially be an exodus from “risk assets” such as equities and bonds. As investors move out of risk assets and into alternative asset classes, gold and precious metals may stand to benefit.
This scenario was seen back in the 1970s. Gold moved higher along with interest rates as stocks and bonds had a challenging time. From 1977 to 1980, interest rates skyrocketed from 4 percent to over 20 percent. Gold saw huge appreciation during this period, rising from less than $200 per ounce to over $800 per ounce.
Clearly, higher interest rates do not necessarily mean lower precious metals…
In the current global financial landscape, emerging markets such as China and India are responsible for a vast percentage of global gold demand. Because of this, rising interest rates in the U.S. will likely not have as much of an influence on the gold price as some anticipate.
Thus, Gold has shown that it can appreciate in value in both falling and rising rate environments.
As the global financial landscape changes, gold may potentially become more useful and important than ever. Stocks have been moving higher for years now, and could be showing signs of cracking.
China has been steadily taking steps to further cement its place among the world’s economic elite. These steps include buying large amounts of gold. The nation’s currency, the yuan, will likely be accepted as an alternative reserve currency, and could pose a serious challenge to the dollar as the global reserve currency of choice…
We believe that the notion of higher interest rates and correspondingly weaker gold is a fallacy. In fact, we feel that now is the opportune time to look at allocations in the precious metals complex, regardless of rising rates.