The mainstream media and investment advisor narrative is that rising interest rates negatively affect the price of gold.
The market expectation is that the gold price will decline as the central banks hike interest rates. This article will explore the relationship between interest rates and the gold price, drawing from an in-depth statistical study – the results of which and the analytic conclusion, may surprise you.
Earlier this year, a popular news outlet published an article that declared: “the price of gold will usually decrease when interest rates rise and increase when interest rates go down.”
It’s amazing how many people will blindly accept that assertion without researching the facts. The author of the aforementioned article must not have had time to conduct the proper due diligence.
Economic Theory Simplified
The flawed notion of an inverse relationship between gold and interest rates is based on the idea that, since holding gold does not earn interest, when rates are low or near zero an investor is indifferent between holding gold as an investment or putting funds in an interest-bearing fund or account. Conversely, when rates rise investors are incentivised to move funds out of gold and into money market funds or T-Bills.
Apart from the direct evidence presented below, there are a couple of flaws in that logic. First, sophisticated gold investors view gold as a wealth-preservation asset and not an interest-bearing investment.
The second problem with the mainstream narrative is that, again, sophisticated investors focus on real interest rates, not nominal rates. The “real” rate of interest is defined as the risk-free rate (Fed funds, LIBOR, short-duration T-Bills) minus the rate of inflation.
The actual rate of inflation is as opposed to the highly flawed CPI inflation rate. While the media promotes the narrative that real rates are now positive, applying inflation measures like the Shadow Government Statistics’ inflation measure to the Fed funds rates shows that real rates are still negative.
History of Interest Rates and Gold Prices
Let’s take a look at the statistical evidence. In 2015, long-time gold market analyst, Adam Hamilton, published an exhaustive statistical study of the relationship between the gold price and interest rates using data going back to 1970. Before I review Adam’s findings, keep in mind that over short periods of time when rates are moving higher, the price of gold will decline.
This is caused by traders who believe the narrative that gold should be sold when rates rise. However, Hamilton’s data mining showed that, between 1970 and 2015, the correlation between the movement in the gold price and the movement in both the 1-year and 10-year Treasury yields was weak at best.
Hamilton studied the effect on the gold price during the Fed’s interest rate hike cycles throughout his study. He found that contrary to the mainstream thinking that some of gold’s best periodic rates of return occur when interest rates are rising. As an example in 1973 and 1974, 1-year Treasury yields rose from 5.7% to 7.4% with rate spikes to as high as 10% during that period. Yet, the price of gold soared 186% over those two years. Similarly, between 2004 and 2006, the Fed took the Fed funds rate from 1% to 5.25% while the price of gold over that period jumped 49.5%.
Gold as a Hedge Against Interest Rate Hikes
After examining and analysing the evidence, contrary to the mainstream belief, interest rate hike cycles are quite bullish for gold (and silver). Let’s test this using the current Fed rate hike cycle.
The Fed began to hike interest rates on March 17, 2022. At the time gold was trading at $1,951. However, the market began taking rates higher at the beginning of 2022, when the 3-month T-Bill rate began rising from 0.25% with the gold price at $1,830.
As of the date this article was written, October 27, 2023, gold closed at 2,016. From the time the Fed began to hike rates through the present, gold has risen 3.3%. But from the time the market began to “force” rates higher (beginning of 2022), gold has risen 7.1%.
To be sure, during that period, gold declined intermittently while rates were rising. But over the entire period, and with the current rate hike cycle still in effect, gold provided a positive investment rate of return. In contrast, between March 17, 2022, and the present, the S&P 500 declined 6.7% and the price of the 10-year Treasury bond fell 14.1%.
Central Banks’ Influence on Gold
Central banks, the entities which control the risk-free rate of interest, clearly understand the wealth preservation and monetary attributes of gold. In 2019 gold was classified by the Basel III Accord as a tier 1 asset.
This means that central banks and banks can use gold as a reserve asset and as banking collateral, placing gold in the same risk-free asset tier as cash, Treasury bonds, European sovereign bonds and other select triple-A rated securities. Contrary to the flawed investing adage that the price of gold falls when interest rates rise, Central banks have been accumulating gold at a record pace since 2022 (per World Gold Council data) while at the same time raising interest rates.
Gold Investment Strategies Amid Rate Hikes
As demonstrated with actual market data going back to 1970, the common belief that gold and interest rates vary inversely is wrong. The evidence, both historical and contemporary, shows that gold performs well as an investment during periods of rising interest rates.
As such, gold both functions as a wealth preservation asset and from time to time it can also function an “alpha” generating investment. While rising interest rates may induce investment out of gold and into fixed-income investments, sophisticated investors armed with the facts will go the other way, removing money from stocks and bonds and into gold and silver.
Dave Kranzler is a hedge fund manager, precious metals analyst and author. After years of trading expertise build-up on Wall Street, Dave now co-manages a Denver-based, precious metals and mining stock investment fund.
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