If you live in the United States, you’ve probably noticed the aptly named “runaway” inflation causing the prices of goods and services to skyrocket. The U.S. Federal Reserve has the power to adjust interest rates in an effort to rein in the economy. In 2022, that’s just what it did.
For the first time since 2018, the U.S. Federal Reserve has decided to raise the target federal funds rate, otherwise referred to, in general partance, as “interest rates.” If you invest in precious metals like gold, you may worry about what this interest rate hike means for the gold price and the security of your investment.
When it comes to gold vs. interest rates, many believe in a negative correlation between the gold price and Federal Reserve rate hikes, but higher interest rates don’t necessarily spell bad news for gold. Let us explain by exploring what interest rates are, how they have affected the price of gold in the past, and what common factors determine gold prices.
What Are Interest Rates?
The Federal Reserve sets the target federal funds rate to manage domestic banks’ interest rates to borrow money from the nation’s central bank.
These federally-mandated rates affect the cost of lending from bank to bank. Banks use these interest rates in overnight loans, when banks and credit unions lend each other the funds they need to finish the day with the proper cash reserves. As rates increase, loans become more expensive not only for lending institutions but also for general consumers.
How Do Interest Rates Affect Me?
When individuals and businesses borrow money from these institutions, they pay the lender a percentage fee based on current interest rates mandated by the Federal Reserve. Rate hikes like the most recent 2022 increase result in higher real interest rates, savings account rates, and credit card rates, making it more difficult for consumers to borrow and spend money.
How Do Interest Rate Hikes Help With Inflation?
When the prices of consumer goods and services inflate, the Federal Reserve may choose to hike up interest rates to quell spending and keep the market in check. When consumers stop spending, prices balance out, at least in theory. The World Gold Council believes the inflation may linger despite the rate hikes.
How Do Interest Rates Affect Gold Prices?
Some believe that the gold vs. interest rates struggle means higher rates will result in a drop in the gold price, but others hold that gold prices following rate hikes have historically disproven that idea. A graph by Visual Capitalist illustrates the median return of gold compared to the U.S. dollar and stocks before and after rate hikes between 1994 and 2015. According to this data, underperforming gold prices tend to rise following interest rate hikes.
One reason for this lies with investors who sell risky stocks and government bonds in search of uncorrelated assets like precious metals. As an increasing number of investors turn to gold, the price of gold rises.
Let’s look at a couple of historical examples of increased gold prices following interest rate hikes:
Alan Greenspan’s 2004 rate hike hit gold at a low $380 per ounce, but the following years marked exponential growth for gold prices. By 2011, the gold price was up 400 percent to roughly $1,900.
At $1,050 four years later, gold prices almost doubled following Janet Yellen’s 2015 rate hike.
Do these examples prove that the gold price will increase following this year’s interest rate hike? Not necessarily: many other factors affect gold prices other than interest rates, including gold supply and demand, investor interests, money supply, and the global gold market.
What Will the 2022 Interest Rate Hike Mean for Gold Prices?
According to the World Gold Council, when it comes to gold vs. interest rates, the 2022 hike offers unique factors due to the likelihood of continued inflation and the state of the global market following the COVID 19 pandemic.
Historically, gold performs well during periods of high inflation and provides investors with reliable risk hedge opportunities. The World Gold Council believes inflation may continue to rise due to COVID-related supply chain and labor market issues.
If you’re a gold investor, you may worry about the U.S. Federal Reserve’s decision to hike rates, but it’s crucial to remember that gold is not just a U.S. market but a global market. Interest rates in other countries worldwide may not rise at the same pace as in the U.S.
The geopolitical climate also affects the price of gold. The increased demand for safe-haven assets following Russia’s February invasion of Ukraine raised the price of gold to over $2,000 per ounce.
What Other Factors Affect the Price of Gold?
The price of gold fluctuates based on so many factors that it proves challenging to list them all here. Other than the factors already discussed, gold prices may also be influenced by:
Gold Supply: Gold prices increase as gold grows more and more scarce.
S. Dollar: In the past, the gold price decreased as the U.S. dollar became stronger, but this correlation does not necessarily indicate cause and effect.
Public Opinion: How the public feels about the Federal Reserve and other central banks can affect the price of gold as people flock to or pull away from traditional investments.
Many economists agree that the price of gold may increase following this recent rate hike, but with so many contributing factors, only time will tell if they’re correct.
Learn More by Contacting Us at Oxford Gold Group
The relationship between gold and interest rates proves tricky to nail down even for expert economists who analyze monetary policies and relationships for a living. Still, we hope this article helps you toward a broader understanding of how interest rates affect the gold market.
At Oxford Gold Group, we aim to help our customers plan for their futures by making informed investments in gold and silver. Let our team provide the tools and guidance you need if you want to start collecting gold or protect your IRA with precious metal backing.
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