Quantitative Easing

Interest rate hikes are coming: what’s next for gold?

This article expresses the point of view of one of our precious metals specialists, based on recent news reports and an opinion-based analysis of the situation. This information should in no way be considered as professional investment advice. As always, we encourage you to consult your financial advisor before making any investment decision.

On March 3, 2022, Fed Chairman Jerome Powell testified before the Senate Banking Committee. Powell pledged to reduce inflation by raising interest rates by 25 basis points at the March 15-16 Federal Open Market Committee (FOMC) meeting. He is confident that the economy is strong and can withstand rate hikes despite the challenges posed by rising oil prices and the conflict in Ukraine. In addition, Mr. Powell commented on supply disruptions lasting longer and having a greater impact on the overall availability of goods and services, which is explained by the speed with which inflation has increased, but firmly believes that rate hikes will not damage the labor market due to the strong outlook and unemployment. rate cut to 3.8% in February.

Definition of a base point

The reason the Fed will raise interest rates to fight inflation is to slow down the velocity of money. The idea is that making silver more expensive will drive some buyers away from auto, housing and other debt-based buying markets. Fewer buyers means lower demand. The drop in demand forces companies to lower their prices to attract consumers to the market. Lower prices have a high long-term economic cost, but offer some short-term financial relief in most sectors.

The best example was during the tenure of Fed Chairman Paul Volcker (1979-1987). During the 1970s and early 1980s, inflation was in the double digits. Volcker raised interest rates to 20% in 1981. One of the first axioms they teach in economics classes, “there’s no free lunch.” Playing with interest rates is no exception. Rising interest rates lowered consumer prices, but led to a two-year recession and double-digit unemployment

Historical interest ratesHistorical interest rates
Historical interest rates

It is widely believed that certain predictable movements occur in different investment asset classes when interest rates rise. Typically, there is a correction in equities and growth in bonds and other fixed income markets. This happens because companies sell at lower prices, making less markup and having higher capital costs, which lowers profits. Investors are rebalancing their portfolios into safer assets like bonds and precious metals. The common belief is that gold is becoming less attractive to conservative investors, so prices pull back because a bond will bring a yield. Despite the frequency of this thought, it is only sometimes true.

What is a yieldWhat is a yield

According to Investopedia, the inverse correlation between rising interest rates and falling gold prices is only 28%, which is not considered statistically significant. Contrary to what most people think, most of the time there is a positive correlation or at least temporarily a positive correlation that when interest rates rise, gold prices also rise. Environments that show a higher correlation between rising rates and falling gold prices increase rates from 0, but are inconsistent when rates start between 1 and 5%.

Instead of saying that there is an inverse correlation between interest rates and gold prices, it is probably more accurate to say that there is a circumstantial correlation between the two. There is a strong correlation between interest rates and the stock market. If the market pulls back enough, this will trigger stop losses in automatic trading accounts (retirements, hedge funds, trading investors, etc.). Since the metals market is so highly leveraged and mostly priced in paper (futures, ETFs, gold mines, etc.), an increase in automated sell orders will cause prices to temporarily pull back. This setback can last for days, weeks, or even months, but is not permanent. Once investors have sold a market, they reallocate their capital across different asset classes.

The most common reallocation strategies turn to bonds, real estate, sometimes cryptocurrencies and, of course, precious metals. When investors switch from paper to metal in their vault, prices tend to rise. The 2008-2011 period is a good example of this portfolio reallocation leading to a spike in metal prices. The stock market was doing great and real estate was in shambles. However, gold has more than doubled in three years. When the Fed started ramping up quantitative easing, that’s when investors sold their gold and the price fell.

The price of goldThe price of gold
The price of gold from 2006 to 2013

It’s possible we’ll see a pullback in gold with interest rate hikes, but the economy is in uncharted territory, so there really isn’t a good playbook to follow. Interest rates do not directly affect the price of gold as much as they affect the behavior of individual and institutional investors. Behavioral finance is a complex mix of finance, economics, and psychology taught in finance schools as an academic major. It is not easy to predict in the short term. However, the long term is another story. In a free market economy, market forces will correct prices and gold will receive a fair valuation far above current levels. In a free market, gold is financial insurance and a good way to protect your purchasing power by protecting you against inflation. If the government is interfering too much in the market and it is no longer true to say it is a free market, then gold is there to protect you from government tyranny and risk. not to physically control your assets.

Whether the Fed is raising rates or postponing them, whether prices are rising or falling, gold and other precious metals should be part of every portfolio. Most investors aim for around 10-20% of their overall portfolio in metals. The best strategy is to keep buying gold at regular intervals at the average dollar cost. Gold returns may not be as exciting as a big winner in the stock market, but that big winner can quickly turn into a big loser. With everything going on in the world, it’s better to have gold and not need it than to need it and not have it. Do you agree? The US Gold Bureau can be contacted at (800) 775-3504.