Gold to soar alongside rising interest rates?

Dear Investor,

In May this year, The Reserve Bank of Australia (RBA) increased interest rates by 0.25%. It was the first time they’d hiked rates since 2010, with most Australians under the age of 35 having never seen an interest rate rise in their adult lives up until that point.

The RBA has since followed that May rate rise with four consecutive 0.50% increases in June, July, August and September, with the cash rate now sitting at 2.35%.

We likely haven’t seen the end of this rate hiking cycle either, with financial markets now predicting interest rates in Australia will rise to just over 3.80% by June 2023.

This can be seen in the below chart from the ASX, which highlights market pricing on the 5th of September, the day before the RBA put through its latest rate hike.

The increase in the local cash rate that we’ve seen in 2022 is aligned with global trends, with most developed market central banks, including The Federal Reserve in the United States, hiking interest rates multiple times this year.

Like Australia, current market pricing in the United States suggest there is also still considerable scope for rates to rise further, and relatively quickly, with the following chart highlighting where interested rates are projected to sit between now and the end of 2024.

This has to be bad for gold, right?

As gold is a non-income producing asset, many people think that higher interest rates are a headwind, and indeed should lead to the gold price falling.

The argument is simple enough.

If interest rates are low and/or falling, then the opportunity cost of owning gold, in terms of interest income foregone, is reduced.

This is supposed to be bullish for gold.

If on the other hand interest rates are rising, like they are now, then the opportunity cost of owning gold, in terms of interest income foregone, is also rising.

This is supposed to be bearish for gold.

The problem with this theory, as logical as it may sound, is that it is not supported by market history.

Gold goes up with higher interest rates

More than 50 years of market data shows that gold has had some of its strongest rallies in time periods that interest rates are rising.
This can be seen in the chart below, which shows the USD gold price per troy ounce, and the Federal Funds rate in the United States from the end of 1970 to end June 2022.

Chart: US Federal Funds Rate and USD Gold Price 1970 to 2022

Source: St Louis Federal Reserve, London Bullion Market Association

The chart shows that while gold has been in bull market phases during periods rates were falling (for example in much of the early 2000s), as logic would suggest, the precious metal has also seen periods of strong price growth when interest rates were rising.

These periods, which are all evident in the chart, include;

• An increase of 224% in the gold price (from USD $48 to USD $156) between February 1972 and July 1974, which coincided with a 9.6% increase in interest rates

• An increase of 292% in the gold price (from USD $132 to USD $518) between January 1977 and April 1980, which coincided with a 13% increase in interest rates

• An increase of 69% in the gold price (from USD $393 to USD $666) between May 2004 and July 2007, which coincided with a 4.3% increase in interest rates

• An increase of 34% in the gold price (from USD $1062 to USD $1428) between December 2015 and July 2019, which coincided with a 2.2% increase in interest rates

The table below summarises these periods:

Table: Periods of interest rate rises, and USD gold price moves

Source: St Louis Federal Reserve, London Bullion Market Association

That gold can perform so well when rates are rising should be no surprise, especially if inflation is also increasing.

After all, the real return on cash in an environment where both interest rates and inflation are 1% (meaning the real cash rate is 0%), is higher than the real return on cash if interest rates are 3%, but inflation is 5% (meaning the real cash rate is -2%), even though interest rates themselves are much higher in the latter scenario.

The fact higher interest rates often cause other problems, from weakness in the economy to downturns in the stock or residential property market, further highlights why rising interest rates can be bullish for gold, as paradoxical as that might seem.

Warm regards,

The ABC Bullion Team