This article explores the relationship between gold and Treasury yields.
The accepted Wall Street and mainstream media narrative is that interest rates and the price of gold move inversely. That is, when rates rise, the gold price declines and vice versa.
Specifically, when the Federal Reserve began to hike the Fed funds rate, the so-called “market experts” predicted that the gold price would decline. As an example, CBSnews.com published an article in March this year titled “How the Fed’s interest rate hike affects gold investing,” which contained this quote: “the price of gold will usually decrease when interest rates rise and increase when interest rates go down.”
The flawed proposition that gold and interest rates are negatively correlated is based on the view that, because gold does not pay interest, money will flow out of gold and into fixed-income securities when rates rise.
Conversely, when rates are low, the opportunity cost of holding gold declines, making gold more attractive as a wealth preservation asset. However, the empirical data shows that there are periods of time when gold and interest rates are correlated, periods of time when the two are inversely correlated, and periods of time when there’s no discernible relationship between gold and Treasury yields.
In general, the relationship between interest rates and gold is unpredictable.
Understanding Treasury Yields
Interest rates are simply the cost of borrowing money. This cost is a reflection of both the duration of the time period for which money is borrowed and the perceived risk of default by the entity or individual borrowing the money.
The Federal Reserve sets the base rate of interest via the Fed funds rate. The yield on Treasuries is derived from the Fed funds rate and is considered the “risk-free” rate of interest because the bonds are guaranteed by the U.S. Government.
The cost of, or interest rate on, all other loan products is derived from Treasury yields.
Historical Analysis of yields and metals
The Fed began hiking interest rates on March 16, 2022. It was the start of what has since been eleven rate hikes, taking the Fed funds target rate from 0% to 0.25% to the current 5.25% to 5.50%.
On March 16, 2022, the 3-month T-bill rate was 2.19% and the price of gold closed that day at $1,927. Currently, the 3-month T-bill rate is 4.47 while the price of gold is $2,003 (as this commentary is being written).
Between March 16, 2022 and now, the 3-month T-bill rate has more than doubled. Though the gold price has been volatile during this time, trading as low as $1,618, since interest rates have risen, over the entire time that the Fed has hiked interest rates the price of gold has increased 3.8%.
But the current Fed rate hike cycle is not the only period of time when gold has performed well after the commencement of a Fed rate hike cycle. The World Gold Council published a report that contained the performance of gold (and U.S. stocks) prior to and subsequent to the last four Fed rate hike cycles:
The chart above shows the rate of return on gold, U.S. stocks and Treasury yields (central banks hold their dollar reserves in Treasuries) 12 months and 6 months prior to and 6 months and 12 months subsequent the start of the last four Fed rate hike cycles.
Not only did the price of gold rise after the commencement of each rate hike cycle, but it outperformed stocks and Treasuries.
The Impact of Treasury Yields on the Gold Price
The price of gold is more closely inversely correlated with the real rate of interest, which is defined as the nominal rate of interest minus the rate of inflation. More specifically, the best periodic rates of return for gold occur when the real rate of interest is negative, or when the rate of inflation exceeds the rate of interest.
This is because negative rates diminish the value of the dollar (or any fiat currency) which in turn means it’s beneficial to hold gold, which holds its value when rates are negative.
Perhaps the biggest factor that affects the gold price is the devaluation of a fiat currency that occurs when a central bank prints money and increases the supply of money. The result is that it takes more units of that currency to purchase goods and services. This includes gold.
Though the price of gold appears to rise in price and value, in effect it takes more of the devalued currency to buy an ounce of gold.
Finally, the flawed notion that gold and rates are negatively correlated completely overlooks the wealth preservation quality of gold. Investors hold gold as an insurance asset for protection against the events precipitated by errant central bank monetary policy and fiscal mismanagement by governments. More to the point, holding gold is insurance against the potential destruction of the value of fiat currency.
As such, it’s difficult to put a value on the insurance policy aspect of gold other than to say that gold becomes invaluable when an economic, financial or geopolitical disaster strikes.
Thus, the decision to invest in physical gold is not predicated on the relative level and variability of interest rates but more so the value assigned by the market to the perceived level of risk of the “disaster” factors listed above.
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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