Best of the Week
Most Popular
1.North Korean Chinese Proxy vs US Military Empire Trending Towards Nuclear War! - Nadeem_Walayat
2.Researchers Find $10 Billion Hidden Treasure In A Dead Volcano - OilPrice_Com
3.Gold and Silver : The Battle for Control - Rambus_Chartology
4.Asda Sales Collapse and Profits Crash! UK Retailer Sector Crisis 2017 - Nadeem_Walayat
5.Deep State Conspiracy or Chaos - James_Quinn
6.The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - Plunger
7.Gold Stocks Coiled Spring - Zeal_LLC
8.Neil Howe: The Amazon-Walmart Rivalry Will Determine the Future of Retail - John_Mauldin
9.Crude Oil Price Precious Metals Link in August - Nadia_Simmons
10.Gold and Silver Precious Metals Nearing Breakout - Jordan_Roy_Byrne
Last 7 days
Global Financial Crisis 10 Years On: Gold Rises 100% from $650 to $1,300 - 23rd Aug 17
GBP/USD Extends Losses - 23rd Aug 17
Donald Trump Terrorist in Chief, “We Aren’t Nation-Building Again, We Are Killing Terrorists” - 23rd Aug 17
How Planned Fed Rate Increases Impact The National Debt & Deficits - 23rd Aug 17
The 3 Assets to Add to Your Stocks Portfolio in This Rate Tightening Cycle - 23rd Aug 17
Half Price UK Theme Parks Entry 2017 With Cheap Chocolate Packs - 23rd Aug 17
[GIFT] Market Control System! - 23rd Aug 17
4 Reasons European Stocks Will Make a Big Comeback This Year - 22nd Aug 17
3 Lesser-Known Charts Revealing a Massive Stock Market Disconnect - 22nd Aug 17
U.S. Treasury Secretary: "I Assume Fort Knox Gold Is Still There" - 22nd Aug 17
Is the Stock Market Setting itself up for a Spectacular Crash? - 22nd Aug 17
Power Elites Launches Civil War Against Trump - 22nd Aug 17
The Stock Market No Longer Cares About Trump - 21st Aug 17
The Coming Boom Of Productivity Will Get Our Economy Back On Track - 21st Aug 17
Buffett Sees Stock Market Crash Coming? His Cash Speaks Louder Than Words - 21st Aug 17
This Could Be The Biggest Gold Discovery In History - 21st Aug 17
Stock Market Correction in Full Swing - 21st Aug 17
Seeking Confirmations – US Stock Market - 21st Aug 17
The changing demographic of online gamblers - 21st Aug 17
Gold is a coiled spring… the breakout is here, fundamentals are in place, technicals are compelling - 20th Aug 17
A Midsummer Night's Dream: Buy Gold and Silver - 20th Aug 17
Gold Mining Stocks 2017 Fundamentals - 20th Aug 17
EIA Weekly Report and Crude Oil - 19th Aug 17
4 Insights for Adjusting Your Portfolio in a Rate-hike Environment - 19th Aug 17
Gold Direction Indicator - 19th Aug 17
Historical Inevitability and Gold and Silver Ownership - 19th Aug 17
You Are Being Lied To About “Low” Gold Demand - 19th Aug 17
This is Why Cocoa's Crash Was a Perfect Setup - 19th Aug 17
Gold, Silver Consolidate On Last Weeks Gains, Palladium Surges 36% YTD To 16 Year High - 19th Aug 17
North Korea Is Far From Being Irrational… It Has A Plan - 18th Aug 17
US Civil War - FUNCTIONAL ILLITERATES TRYING TO ERASE HISTORY - 18th Aug 17
Bitcoin Hits New All-Time High Over $4,400 As It Catches Paypal In Total Market Cap - 17th Aug 17
3 Psychological Ingredients behind Great Web Content - 17th Aug 17
The War on Cash - Rogoff, Orwell and Kafka - 17th Aug 17
The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - 16th Aug 17
Stocks, Bonds, Interest Rates, and Serbia, Camp Kotok 2017 - 16th Aug 17
U.S. Stock Market: Sunrise ... Sunset - 16th Aug 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

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


© 2005-2017 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

Catching a Falling Financial Knife