Thursday , 21 November 2024

What Do Current Low Interest Rates Mean For the Future Price of Gold? (+3K Views)

Lorimer Wilson September 2, 2014 6 Comments 4,263 Views

Investors commonly assume that rising interest rates adversely impact the goldInterest-Rates 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. Let me explain why that is the case ans why, as such, gold investors shouldn’t fear rising interest rates.

The above introductory comments are edited excerpts from an article* by Ben Kramer-Miller (goldstockbull.com) entitled Gold Investors Shouldn’t Fear Rising Interest Rates.

The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and the FREE Market Intelligence Report newsletter (sample here).  This paragraph must be included in any article re-posting to avoid copyright infringement.

Kramer-Miller goes on to say in further edited excerpts:

[In fact,] since Nixon abandoned the gold standard (i.e. after August 15th, 1971) 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… and…
  • assets that do not have any yield (i.e. gold and other commodities) become less attractive from an investment standpoint.

When the Fed Funds Rate rises the 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 and, as

  • money comes out of income generating assets and finds a home in assets whose value is intrinsic.
[For example,] 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.

Conclusion

1. With the Fed Funds Rate at 0.1%, it is evident that gold is positioned to move substantially higher.

2. 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.

3. Interest rates cannot stay low forever, however, so, 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.

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

*http://www.goldstockbull.com/articles/gold-investors-should-not-fear-rising-interst-rates/ (Copyright © 2014 Gold Stock Bull – All Rights Reserved.)

If you liked this article then “Follow the munKNEE” & get each new post via

Related Articles:

1. Will Higher Interest Rates Result From Additional Tapering?

After a long period of very low interest rates following the global financial crisis the central banks of the U.S. and U.K. are planning to gradually tighten their easy monetary policies as their economies improve. When their benchmark interest rates go up, interest rates elsewhere will go up to so should we worry if and when global financial conditions tighten? Read More »

2. We’re Doomed! Rising Interest Rates Will Cause Our Financial System To Implode

We’re doomed! Even if the economy were growing at a faster pace, it wouldn’t come close to offsetting the interest payments on our ever-expanding debt. As such, any sort of credit shock – either rising rates or a decline in the rate of debt expansion – will cause the system to implode. Let me explain why that is the case. Read More »

Everyone knows that interest rates are going to rise in the future so the real question is not whether they will rise, but when and by how much. [This article analyzes when that will most likely be.] Read More »
4 economic conditions need to be in place for interest rates to rise ahead of – and independent of – the Fed’s forward guidance. The economy met only one of those conditions to date but will likely meet all four by the end of the year…What follows is a status report on the four conditions. Read More »
Everyone and their mom is expecting long-term interest rates to rise now that the Fed is tapering its bond buying programs. I have a couple of problems with this line of thinking because, although it seems like reducing demand for a security (i.e. tapering QE) would result in a drop in price, when you really think about how quantitative easing works this makes no sense and, secondly, the market is telling us this makes no sense. Let me explain. Read More »
There is one vitally important number that everyone needs to be watching right now, and it doesn’t have anything to do with unemployment, inflation or housing. If this number gets too high, it will collapse the entire U.S. financial system. The number that I am talking about is the yield on 10 year U.S. Treasuries. Here’s why. Words: 1161; Charts: 2 Read More »
It seems that the past few years of falling interest rates have lulled a big part of the global economy into financing with variable-rate debt…[As such,] when interest rates go up (as they did last week), there’s a world-wide reset in interest costs that, best case, amounts to a tax increase on individuals and businesses and, worst-case, threatens to blow up the whole system. Read More »
What does it look like when a 30 year bull market ends abruptly? What happens when bond yields start doing things that they haven’t done in 50 years? If your answer to those questions involves the word “slaughter”, you are probably on the right track. Right now, bonds are being absolutely slaughtered, and this is only just the beginning. So why should the average American care about this? Read More »
The global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar. So what does all this mean exactly? [Let me explain.] Read More »
If yields on U.S. Treasury bonds keep rising, things are going to get very messy. What we are ultimately looking at is a sell-off very similar to 2008, only this time we will have to deal with rising interest rates at the same time. The conditions for a “perfect storm” are rapidly developing, and if something is not done we could eventually have a credit crunch unlike anything that we have ever seen before in modern times. Let me explain. Read More »
[While]… I am not currently predicting an acceleration in inflation [I believe]…that the risk of interest rate instability is very real [given that] core inflation is already above a key benchmark that the Fed has staked its credibility on,. It should be of concern to investors that, despite economic growth being so anemic and overall resource utilization being so low (including human resources), there is currently very little margin for error on the inflation front. [In this article the author evaluates the danger that rising interest rates could potentially have on the U.S. economy.] Words: 2050 Read More »
The once unthinkable might become policy: negative nominal interest rates. Investors should care as they may be increasingly punished for not taking risks yet masochistic investors believe they may be the prudent ones given the risks lurking in the markets. What are investors to do, and what are the implications for the U.S. dollar and currencies? Words: 779 Read More »
Interest rates have been manipulated to keep them extremely low in an attempt to stimulate the economy but…unless deficits are dramatically reduced…. interest rates will eventually rise and government interest expense will double or triple from the amounts being paid today. That potentially triggers a debt death spiral, where government has to borrow more than otherwise expected. It also raises the credit risk and could ratchet interest rates up again. It has happened to Greece, Portugal, Spain and other European countries already this year and could well happen in the U.S. too. Words: 595 Read More »
Everyone who purchases a Treasury bond is purchasing a depreciating asset. Moreover, the capital risk of investing in Treasuries is very high. The low interest rate means that the price paid for the bond is very high. A rise in interest rates, which must come sooner or later, will collapse the price of the bonds and inflict capital losses on bond holders, both domestic and foreign. The question is: when is sooner or later? The purpose of this article is to examine that question. Words: 2600 Read More »
Countering Krugman’s argument that today’s low interest rates show that no one is worried about lending money to us and, therefore, that we should borrow and spend our way to prosperity, Ferguson argues that today’s interest rates are irrelevant. When countries get into trouble, he says, they get into trouble quickly – the way Greece and other European countries have. Taking … Read More »
Right now, interest rates are near historic lows. The U.S. government is able to borrow gigantic mountains of money for next to nothing. U.S. consumers are still able to get home loans, car loans and student loans at ridiculously low interest rates. When this low interest rate environment changes (and it will), it is going to absolutely devastate the U.S. economy. Without low interest rates, the U.S. financial system dies. [Let me explain.] Words: 1529 Read More »
Brace yourself for one of the greatest interest-rate surges in decades — beginning first in the long-term Treasury markets … later spreading to shorter term Treasuries … and ultimately enveloping nearly every loan, debt, credit, and money market instrument on the planet. This rise may not begin with great fanfare, nor will it immediately upset the apple cart of the economic recovery, but with the march of time, it WILL gain momentum and reach critical mass. Words: 614 Read More »

 

6 comments

  1. SeniorD
    September 1, 2014 at 6:04 pm

    Generally speaking, as Gold moves, so moves Silver and the rest of the PM’s…

© 2024 munKNEE.com. All Rights Reserved