What does an interest rate hike mean for the price of gold?

Interest rates are rising again, which is putting pressure on stock prices. Technology stocks have already fallen in value by almost 10% from the highest level. Investors fear that a rate hike by the Federal Reserve will put even more pressure on prices. But what does that scenario mean for the gold price?

Is rising interest rates by definition also unfavorable for gold? We have already posted on Holland Gold several times written about the correlation between the price of gold and real interest rates. If interest rates fall after correction for inflation - the real interest rate - then it is more attractive to own gold. The precious metal does not earn interest, but that is more than negative interest on savings. However, if interest rates rise, it becomes less attractive to buy gold. So much for the theory. What can we expect now that the U.S. central bank is planning to raise interest rates?

Long-term interest rates continue to rise

This week, German 10-year yields returned for the first time since 2019 above zero which means that these bonds will give a positive return again. In the United States, too, long-term interest rates are rising rapidly. A U.S. 10-year Treasury delivers at the time of writing 1,85% the highest level since December 2019. This trend of rising interest rates put the Gold price under pressure last year. In euros, the price rose by only 3%, while in dollars it fell by 3.5% on balance last year. The prospect that central banks will also raise interest rates does not bode well for gold, but history teaches us that it is actually not that bad.

What does an interest rate hike mean for gold?

In a preview for this year, the World Gold Council that a tightening of monetary policy by the Federal Reserve usually has a positive effect. In the run-up to an interest rate hike or balance sheet reduction, the precious metal appears to perform much worse than the stock market, but once the interest rate hike has taken place, the precious metal appears to perform better again. Based on various periods of monetary tightening in the recent past (February 1994, June 1999, June 2004 and December 2015), the precious metal appears to be stronger on balance. In the first six months after these four periods of monetary tightening, the gold price appears to rise by more than 10% on average. A year after the tightening, the price had risen about 7.5% on average. A clear case of 'buy the rumour, sell the news', but in reverse.

How is gold price reacting to monetary tightening by the Fed? (Source: World Gold Council)

This time is different?

If we take recent history as a guide, then a rate hike by the Fed should be a good time to buy gold. Why the gold price falls in the run-up to the interest rate hike and then rises again is a good question. The market may be exaggerating the effect of the rate hike or the speed at which the central bank raises its policy rate. Of course, we cannot say for sure whether things will go back to the way they did in the previous four phases of monetary tightening. However, we can conclude that the fundamentals for gold are still very favorable. Interest rates may be rising, but they are completely insufficient to keep up with high inflation. After all, inflation hasn't been as high as it is now in decades. The inflation in the eurozone rose to 5% year-on-year in December, but is much higher in some countries. Real interest rates have not been as negative as they are now since the 1970s. An interest rate hike by central banks will do little to change that. So it remains interesting to own precious metals to protect your assets.

Disclaimer: Holland Gold does not provide investment advice and this article should not be considered as such. Past performance is no guarantee of future results.

This contribution comes from Geotrendlines