Posted 29th Mai 2024

How the Fed Funds Rate Impacts Gold and Silver Prices

The relationship between the Federal Reserve’s interest rate policies and the effect on the gold price and silver price is multifaceted. 

In the short term, gold and silver prices react inversely to the directional move of the Fed funds rate. The Fed funds rate is the interest rate at which depository institutions trade federal funds, balances held at Federal Reserve Banks, with each other overnight. 

However, the longer-term effect of Fed policy on gold and silver is more correlated with Fed policy implementation that has severely devalued the U.S. dollar since 1971. 

Understanding how these rates influence gold and silver prices is essential for anyone looking to invest and trade gold and silver. 

The Fed Funds Rate Explained

The Fed funds rate is the baseline interest rate from which the rates on all other forms of lending are derived. 

The Fed uses the Fed funds rate as one of its monetary policy tools to achieve full employment and stable prices. 

Why do Fed Rates Impact Commodity Prices?

Gold is traditionally seen as a hedge against inflation (fiat currency devaluation) and economic instability. Several key mechanisms can explain its relationship with the Fed funds rate.

Opportunity Cost

When the Fed raises interest rates, the opportunity cost of holding non-yielding assets like gold increases. Investors might prefer interest-bearing assets like bonds over gold, leading to a decline in the gold price.  

Conversely, when the Fed cuts interest rates, the lower opportunity cost makes gold more attractive, potentially increasing its price. Keep in mind that this is a commonly held belief. 

Physical gold and silver are often a cornerstone in many investment portfolios and are seen widely as a wealth preservation hedge against the ongoing devaluation of fiat currencies by Central Banks globally. Over time, gold has been moving higher regardless of the level of the Fed funds rate:

The chart shows that since 2001, when the current secular precious metals bull market commenced, the Fed funds rate has oscillated between 5.5% and 0%. The price of gold has generally been rising regardless of the level of the Fed funds rate. This is particularly true since the Fed’s latest rate-hike cycle. 

While it’s possible to take advantage of „knee-jerk“ reactions in the market in anticipation of a change in the Fed funds rate, the prices of gold and silver have risen over longer periods of time regardless of the relative level of the Fed funds rate. The chart above only goes back to 2001. The result is the same if it shows 1971 to the present. 

Impact on Silver Prices 

Silver is both a monetary metal and an industrial metal. Silver is a key input for technology and industrial applications as well as for military hardware. This duality means its price is influenced by both investment demand and industrial demand. As a monetary metal, the price of silver is subject to short-term volatility based on Fed interest rate policy. As an industrial metal, the price is influenced by the ebb and flow of industrial demand as well as the relative supply of silver to fulfil this source of demand.  

The relationship between the Fed funds rate and precious metals has been particularly evident in recent years. For instance, during the COVID-19 pandemic, the Fed slashed interest rates to near-zero levels to support the economy. This policy, along with massive fiscal stimulus, led to a surge in gold and silver prices as investors sought refuge from economic uncertainty and anticipated future inflation.

As of March 2022, the Fed began hiking rates from 0% with gold just below $1900. Fast-forward to today, the Fed has taken the Fed funds rate to 5.5%, yet the price of gold is over $2400. The point here is that the prices of gold and silver are predicated more on hedging against fiat currency devaluation than the level of interest rates.

How Can Investors Capitalise From Gold and Silver vs Fed Rate Policy

Understanding the Fed funds rate’s impact on gold and silver prices is crucial for making informed investment decisions. Here are some strategic considerations:

Core holding vs speculative trend trading

It’s prudent to hold at least 10% of one’s investment portfolio in physical gold and silver. How you allocate between the two is a personal preference but currently, silver is historically undervalued relative to gold and it might pay off to hold more silver than gold right now.

Beyond core holding in gold and silver, analysing the Fed’s policy statements and economic indicators can provide insights into future interest rate movements. This can help investors anticipate market reactions and adjust their portfolios accordingly. It can also facilitate profitable trading on short-term gold and silver price volatility. But remember that, for now, the longer-term trend is for gold and silver to move higher in price. 

While short-term fluctuations in gold and silver prices can be influenced by Fed interest rate changes, long-term trends are driven by broader economic and geopolitical factors. Maintaining a long-term perspective can help investors ride out volatility and benefit from the overall appreciation of these metals.

Is There Gold and Silver in the Federal Reserve? 

The simple answer is „yes.“ The Fed acts as a safekeeping custodian for foreign Central Banks and foreign Governments. The Fed also is the custodian for the alleged 8100 tonnes of gold owned by the U.S. Treasury. However, whether or not legal title to this gold still resides with the U.S. Treasury or if the gold has been rehypothecated and used for other purposes (swaps, gold leases or other types of encumbrances). 

To that point, the last credible, independent audit of the gold held by the Fed on behalf of the Treasury was in 1953. The U.S. Treasury has not permitted an audit, assay and inventory accounting of the United States‘ gold reserves since 1953. Over the last 25 years, there have been intermittent attempts by some Congressmen to pass a Bill requiring an official, independent audit of the Fed, including its gold holdings. Each time the Fed waged a campaign in Congress to defeat the proposed legislation. Thus, while the Fed likely still holds gold on behalf of official foreign entities, it’s not clear if, and how much, it still retains legal possession of the Treasury’s gold. 

The Fed funds rate plays a significant role in shaping the economic environment, directly impacting the prices of gold and silver on a short-term basis. This knowledge can facilitate profitable short-term trading strategies. However, over longer periods of time, the evidence shows that the Fed funds rate has no bearing on the market value of 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.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The opinions expressed in this article, do not purport to reflect the official policy or position of Kinesis.

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