Even with rising interest rates and the dollar at multi-year highs, gold has held its ground. Nevertheless, we have yet to see a big spike in gold prices despite persistent inflation. Why not?
The perception is that rising interest rates are always bad for gold. But does perception match up with reality?
If history is any indication, the answer is no.
Nevertheless, with the Federal Reserve delivering its biggest rate hike since 1994, the mainstream has remained wary. Even before the Fed started raising rates, the anticipation of the central bank aggressively fighting inflation created headwinds for gold. But a careful look at history reveals that we are nowhere near an interest rate environment that should negatively impact gold.
At some point, we should expect a revision as the mean as markets come to grips with reality and recognize that real interest rates aren’t going to rise high enough to undermine gold’s performance.
Holding gold does not generate interest income like a bond or a bank account. If interest rates rise and you’re holding gold, you’re forgoing the interest income you could earn if you instead owned a bond or put dollars in a money market account. That’s why rising interest rates tend to create headwinds for gold. And it’s why we’ve seen gold sell off on high inflation news. The markets expect the Fed to fight inflation with rate hikes, thus raising the opportunity cost of holding gold.
But despite the recent hikes, interest rates remain deeply negative. And they will likely remain that way for a long time. Real interest rates equal the nominal rate (the numbers quoted on the news) minus inflation. Today, the nominal rate is 1.5%. Inflation is running at around 8.6% (using the cooked government numbers). So, the real interest rate is -7.1.
To state the obvious, there is no “opportunity cost” in holding gold when real rates are deeply negative.
For the sake of argument, let’s assume the Fed manages to meet its projections and can bring the CPI back down to 2.3% by 2024 with a terminal rate of 3.8%. This would yield a real rate of 1.5% (I find this scenario implausible given that we’re already at the point where rate hikes will likely pop the economic bubble and precipitate a massive crash in the economy – but again, we’re accepting the Fed projection to make a point.)
Even if short-term interest rates climb to 1.5% in real terms, they would remain below an interest rate environment that is historically negative for gold.
In fact, according to an analysis by the World Gold Council, real yields below 2.5% have not been substantially negative for gold. You have to get into a high real rate environment before you see negative returns on gold.
Our analysis suggests that US real rates would need to move above 2.5% for there to be a meaningful long-term negative impact on gold. A return to a real rate environment of 0–2.5% would likely impact gold, but only to the extent of it realizing slightly below its long-term average real return of 6.1% Rising rates certainly provide more headwinds to gold than falling rates, but gold can still provide positive real returns in a rising rate environment. Historically, it required an interest rate environment of over 2.5% in real terms to have a significant negative impact on gold prices.”
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