Best of the Week
Most Popular
1.U.S. Inner City Turmoil and Other Crises: Ron Pauls Predictions for 2015 - Dr_Ron_Paul
2. What’s In Store For Gold Price in 2015? - Ben Kramer-Miller
3.Crude Oil Price Ten Year Forecast to 2025: Importers Set to Receive a $600 Billion Refund - Andrew_Butter
4.Je ne suis pas Charlie - I am not Charlie - Nadeem_Walayat
5.The New Normal for Oil? - Marin_Katusa
6.Will Collapse in Oil Price Cause a Stock Market Crash? - OilPrice.com
7.UK CPI Inflation Smoke and Mirrors Deflation Warning, Inflation Mega-trend is Exponential - Nadeem_Walayat
8.Winter Storms Snow and Wind Tree Damage Dangers, DIY Pruning - Nadeem_Walayat
9.Oil Price Crash and SNP Independent Scotland Economic Collapse Bankruptcy - Nadeem_Walayat
10.U.S. Housing Market Bubble 2.0 Meet the Pin - James_Quinn
Last 5 days
Stock Market Major 4 or Primary IV Wave - 31st Jan 15
Gold And Silver Price Probability for A Lower Low Has Increased - 31st Jan 15
U.S. Bond Market Has Reached Tulip Bubble Proportions - 31st Jan 15
The 3 Big Reasons My Apple Stock Price Prediction Is Still Coming True - 31st Jan 15
199 Days of Hell - Unintended consequences: Oil and the Worst Battle in History - 31st Jan 15
Kaminak Yukon Gold - 30th Jan 15
U.S. Asset Price Deflation Coming Up? Food Prices Drop? CPI Negative? Credit Deflation? - 30th Jan 15
An Often Overlooked Predator: State Governments and Income Taxes - 30th Jan 15
Bullard Says Rates at Zero Interest Rates Not Right for U.S. Economy - 30th Jan 15
Why the European Central Bank's Massive Economic Experiment Will Fail - 30th Jan 15
Gold Price Short-Term Bottom Due, Higher into February - 30th Jan 15
Silver and Other Precious Metals To Manipulate - 30th Jan 15
Socialism Is Like a Nude Beach - Sounds Like a Great Idea Until You Get There - 30th Jan 15
To Create Unlimited Market Liquidity or Not; That Is the Question - 30th Jan 15
Seen the Energy Downturn Movie Before, and Not Worried - 30th Jan 15
It’s Not Time to Sell Everything – Yet - 30th Jan 15
13 Investment Themes for 2015 - 29th Jan 15
The Raging Currency Wars Across Europe - 29th Jan 15
The End of Currency 'Safe-Havens' - 29th Jan 15
Ron Paul on U.S. Fed, Central Bankers Monetary Psychopaths - 29th Jan 15
Why Microsoft Stock Will Provide Major Investing Returns - 29th Jan 15
Exploring the Clash Within Civilizations - Mind the Gap - 29th Jan 15
Saudi Arabia Changes Kings, But Not its Oil Policy - 29th Jan 15
Crude Oil Price Bulls vs. Resistance Zone - 28th Jan 15
Acceleration Of Events With Rising Chaos – US Dollar Death Foretold - 28th Jan 15
The Fed and ECB Take the West back to when the Rich Owned Everything - 28th Jan 15
Washington's War on Russia - 28th Jan 15
Cyber War Poses Risks To Banks and Deposits - 28th Jan 15
Lies And Deception In Ukraine's Energy Sector - 28th Jan 15
EUR, AUD, GBP USD – Invalidation of Breakdown - 28th Jan 15
“Backup-Camera Envy” Is Driving This Unstoppaple Investment Trend - 28th Jan 15
The Great "inflated" Expectations for Gold, Oil, Commodities -- and Now Stocks - 28th Jan 15
How to Find the Best Offshore Banks - 28th Jan 15
There’s More to the Gold Price Rally Than European Market Fears - 28th Jan 15
Bitcoin Price Tense Days Ahead - 27th Jan 15
The Most Overlooked “Buy” Signal in the Stock Market - 27th Jan 15
Gold's Time Has Come - 27th Jan 15
France America And Religious Terror War - 27th Jan 15
The New Drivers of Europe's Geopolitics - 27th Jan 15
Gold And Silver - Around The FX World In Charts - 27th Jan 15
It’s Not The Greeks Who Failed, It’s The EU - 27th Jan 15
Gold and Silver Stocks Investing Basics - 27th Jan 15
Stock Market Test of Strength - 26th Jan 15
Is the Gold Price Rally Over? - 26th Jan 15
ECB QE Action - Canary’s Alive & Well - 26th Jan 15
Possible Stock Market Pop-n-drop in Store For SPX - 26th Jan 15
Risk of New Debt Crisis After Syriza Victory In Greece - 26th Jan 15
How Eurozone QE Works: A Guide to Draghi's News - 26th Jan 15
Comprehensive Silver Price Chart Analysis - 26th Jan 15
Stock Market More Retracement Expected - 26th Jan 15
Decoding the Gold COTs: Myth vs Reality - 26th Jan 15
Greece Votes for Syriza Hyperinflation - Threatening Euro-zone Collapse or Perpetual Free Lunch - 26th Jan 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Learn to Trade

Gold Investors Shouldn’t Fear Rising Interest Rates: Here’s Why

Commodities / Gold and Silver 2014 Aug 06, 2014 - 07:15 AM GMT

By: Jason_Hamlin

Commodities

Investors commonly assume that rising interest rates adversely impact the gold price, and vise versa.  They 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.  They 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.


But this intuition is unfounded, at least when tracking the Fed Funds Rate since the Nixon abandoned the gold standard (i.e. after August 15th, 1971). Since then, a rising Fed Funds Rate has usually coincided with rising gold prices, and vise versa.

Consider the following data (gold price data is from Kitco, Fed Funds Rate data is from the St. Louis Fed):

  • 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%.
  • From January 1975 through August 1976 the gold price dropped to just over $100/oz, while the Fed Funds Rate fell to 5.25%.
  • In January of 1980 the gold price peaked at over $800/oz while the Fed Funds Rate rose to 14%.
  • The gold price then fell to about $290/oz in late February, 1985, while the Fed Funds Rate fell to 8.6%.
  • 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%.
  • However the trend continues as the gold price fell to $330 in March, 1993 while the Fed Funds Rate fell to 3%.
  • The gold price then rose to $415 in February, 1996 while the Fed Funds Rate rose  to 5.2%.
  • The gold price then fell until hitting its September, 1999 bear market bottom at $255. This occurred just before the Washington Agreement on Gold was signed, while the Fed Funds Rate remained steady.

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.

gold chart

(Source: The Fed Funds Chart comes from TradingEconomics.com and the gold price chart comes from ChartsRUs.com)

What causes this strong correlation?

When the Fed Funds Rate falls this creates a carry trade that allows banks to borrow cheap money from the Fed in order to buy assets with higher yields.  It follows that bonds and stocks–or assets that have value insofar as they have a yield–become more attractive by comparison. More generally, when interest rates fall, the yield on interest-bearing assets becomes more attractive.  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.

Similarly, when the Fed Funds Rate rises this carry trade dissipates.  Banks have to pay more in order to borrow, and so they are less willing to bid up the prices of income generating assets.  As money comes out of these assets it finds a home in assets whose value is intrinsic.

So a bank can make money if it borrows money from the Fed at 5% to buy an asset yielding 5.5%.  But if the Fed raises the Fed Funds Rate to 6%, that bank suddenly has to sell the asset yielding 5.5% or else it begins to lose money on the trade. Similarly, 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.

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.  Similarly a low interest rate is an indication that investors should buy gold, whereas a declining interest rate acts as a headwind.  It follows that 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.

With the Fed Funds Rate at 0.1%, it is evident that gold is positioned to move substantially higher.  Low 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 “anti-bubble” in gold and other commodities.  But interest rates cannot stay low forever. While the Fed’s low interest rate policy is pushing stock and bond prices higher, it is also infusing potential energy into the gold market.

Therefore, it is only a matter of “When?” and not “If?” this trend reverses and gold catapults higher.

By Jason Hamlin

http://www.goldstockbull.com/

Jason Hamlin is the founder of Gold Stock Bull and publishes a monthly contrarian newsletter that contains in-depth research into the markets with a focus on finding undervalued gold and silver mining companies. The Premium Membership includes the newsletter, real-time access to the model portfolio and email trade alerts whenever Jason is buying or selling. You can try it for just $35/month by clicking here.

Copyright © 2014 Gold Stock Bull - All Rights Reserved

All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. The information on this site has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on


© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014