Learned wisdom

According to conventional wisdom in the financial markets, gold rates are inversely proportional to Fed interest rates in that during times of ultra-loose financial policy measures, gold prices increase.

Also, since monetary stimulus such as quantitative easing can pave way for inflation, the demand for the precious yellow metal may increase given that it is considered a good hedge against inflation. As is the case with other commodities, gold prices are determined by the supply and demand trajectory on a global scale. However, it is important to note that changes in the supply side of gold occur very slowly and therefore, any wide fluctuations at the margin originate from the demand side and more so the investment side. While the jury is still out on whether the gold prices fall as a direct result of Fed rate hikes, there is a view that around four-fifths of the yellow metal’s bullish run during 1970-80 can be attributed and even mathematically proved to be a result of rising interest rates at the time.

Gold prices and rate hikes

Intriguingly, the bullish gold market of the 1970s was witnessed during times of high interest rates. According to a school of thought which goes against this grain of the aforementioned conventional wisdom, traders, across the globe seek status qua and more often than not, base their decision on fear about any change in market conditions and therefore, chose to believe that stock markets will rally without any corrections. However, there is considerable evidence which reveals how gold price in 1973 and 1974 increased owing to Fed rate hikes. Likewise, gold price fell in 1975-76 on the back of plummeting interest rates. Again, there was a hike in the price of gold in 1978 and 1979 as interest rates rose.

capital-economics-us-treasurys-gold-price

There is a view that rising interest rates prove to be bullish for gold since the former is bearish for stocks. When conventional asset are taking a beating, several investors flock towards the yellow metal. Rising rates, in many ways, result in overvaluation of stock markets, as it were. It has been observed that during times of higher interest rates, corporate profits are hit, which result in reduced earnings. According to experts, stock markets, decline during interest rate hikes. As a result, investors seek solace in alternative investments such as gold. For instance, when gold prices rose by 186% in 1973-74, the S&P 500 fell by 42% during the same period. Likewise, when the S&P 500 index rose by 57% in 1975-76, the price of gold plummeted by 28% in the same period. During the last big rate-hike cycle between June 2004 and 2006 when Fed raised interest rates to 5.25%, the price of gold rose by 49.5%. One of the other woes faced by the precious yellow metal is the US monthly jobs report. Traders in gold futures tend to panic on the prospect of a rosy US jobs report, anticipating a Fed rate hike.

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