What Happens to Gold when Interest Rates Fluctuate?

stack of gold coins increasing with an economic chart in the background

Gold is one of the most valuable assets for investment portfolios. Therefore, a good understanding of the indicators that directly influence its value can significantly impact your bottom line.

Interest rates are one of the widely touted indicators of gold price movement, but the relationship is more complex.

This article will look at the relationship between gold prices and interest rates fluctuation.

Interest Rates Explained

The federal funds interest rate (the focus of this article) is the target interest rate set by the Federal Open Market Committee (FOMC). It is the target rate the Fed recommends for inter-commercial bank borrowing and lending.

The FOMC is part of the Federal Reserve System. They meet eight times each year to set the target rate to encourage economic growth.

The rate-setting committee can cut the rates for borrowing money or increase them in line with current economic realities.

When Interest Rates Rise

Interest rates increase with growing economic confidence. During economic growth, consumers and businesses have more purchasing power.

With a rise in disposable income, consumers typically request more car loans, take out mortgages, etc. Central banks theoretically expect greater returns from loans as the cost of borrowing increases.

Sometimes, the Fed uses interest rate increases to fight rising inflation.

With prices rising fast, central banks increase the interest rates to encourage people to save more money and reduce spending.

When the FOMC increases interest rates, investors typically buy more U.S. stocks and other securities. As the prices of these assets rise, the exchange rates for the dollar also rise.

If the value of the dollar increases compared to other major currencies around the world, the price of gold generally declines.

Additionally, gold loses its status as a safe-haven investment during protracted periods of economic growth, further accelerating a decline.

When Interest Rates Fall

red icon of interest going down with coins on the background

The Fed reduces interest rates or keeps them at 0% in periods of economic stagnation when confidence pales. The economic slowdown affects wage growth, unemployment, and the cost of living.

It will also cause the value of the dollar to fall compared to other global currencies.

During these periods, gold assumes its safe-haven status as investors turn to it to protect their assets. The result is an increase in gold prices.

Due to the behavior of gold during interest rates fluctuation, many analysts have claimed that the metal has a negative correlation to interest rates.

Why is the U.S. Fed Rate Important the Important Determinant of Gold Prices?

Interest rates worldwide affect the price of gold in individual countries differently. However, the U.S. rates are most important because investors predominantly trade gold in U.S. Dollars.

Therefore, any policies that will affect the U.S. currency (which include the interest rates) can impact the price of the metal.

Negative Correlation Between Gold and Interest Rates: Facts or Fiction?

The idea of a negative correlation between gold and interest rates has persisted for a long time. However, as any avid gold trader will agree, it’s not that cut and dry.

There have been many periods of negative correlation in recent history. However, a holistic look at gold prices juxtaposed against interest rates fluctuation suggests that any such correlation is circumstantial at best.

A Look at Historical Evidence

Since 1970, gold has shown a correlation of any kind (positive or negative) to interest rates only about 30% of the time. This frequency is not significant enough to form any strong opinions.

We’ll look at the price movement in the 1970s, 1980s, and during the 2000s and 2010s.

Gold Price and Interest Rate Relationship in the 1970s and 1980s

During the gold bull market of the 1970s, the metal hit its first all-time high price of the 20th century. However, the run occurred during a period of high and fast-rising interest rates.

The short-term interest rates were 3.5% in 1971. By 1980, the interest rate had more than quadrupled, with a high of 16%.

During those nine years, the price of gold ballooned from less than $50 per ounce to an unprecedented (at the time) $850 an ounce. So, during this period, gold positively correlated with interest rates.

The positive correlation is even stronger when you zoom in on short-term trends. The first part of the steep rise in gold price came between 1973 and 1974 when the interest rate also rose quickly.

The interest rates fell between 1975 and 1976, and gold prices also slightly tapered off. As interest rates resumed an upward trajectory in 1978, gold prices also followed.

In the 1980s, gold entered a bear market during a period when interest rates were also on a steady decline.

Gold Price and Interest Rate Relationship in the 2000s and 2010s

money in a bag with a red arrow down

During the 2000s, gold shifted to a negative correlation with interest rates. The bull run in the first few years following the turn of the millennium coincided with lower interest rates.

In 2001, gold prices increased as interest rates fell. By November of 2002, the feds reduced interest rates, and gold prices also rose. The relationship also repeats during 2007-2008, 2009-2016, and 2017-2018.

However, there were some notable disparities.

In 2005-2006, gold and interest rates rose together for a while. Between 2009 and 2016, gold peaked and fell, even during periods with interest rates at 0%. Most recently, in 2019-2020, gold prices increased even as rates remained steady and rose.

Going by the negative correlation theory, gold prices should have maintained a steep climb following the Fed’s actions post the 2008 financial crisis.

The metal also shouldn’t have advanced by more than 49% between 2004 and 2006 as the federal funds rates climbed from 1% to 5%.

What is the Main Driver of Gold Prices?

Seeing how the negative correlation theory isn’t an indisputable fact, you may be wondering about the main driver of gold prices.

Like other commodities, supply and demand are the ultimate drivers of gold prices over the long term. Surges in supply can force the price of gold down.

However, converting a newly discovered gold deposit into a functional mine takes at least ten years. Thus, price changes due to supply are very slow.

Demand is often the more dominant price driver. Gold prices can soar if investors have cause to flock to gold en masse as a safe haven during periods of uncertainty.

Should Investors Time the Gold Market with Interest Rate Decisions?

As seen above, the negative (or positive) correlation theory doesn’t always hold. If you fancy succeeding only 30% of the time, you can consider taking gold positions based on federal funds rates.

The 30% mark is also optimistic if you don’t intend to hold for the long term. Gold prices don’t move in a straight line.

Therefore, even when the negative correlation rings true, you may still buy into periods of short-term retracement.

Again, even seasoned analysts expecting interest rates to rise don’t always get it right. An average investor won’t be any more successful.

Interest rates will occasionally have a short-term influence on gold prices, but the actual price movement hinges on the broader economic outlook.

Is Gold Still a Hedge Against Inflation?

inflation written on a calculator

Gold is still a hedge against inflation. The metal is highly liquid and without credit risks. It’s always in demand for luxury items (including jewelry) and used in numerous industrial applications.

Therefore, it retains its value over time, making it a good hedge against inflation.

However, looking at the price movement analysis above, it’s clear that gold is a good hedge against inflation only if you hold it long-term.

One of the best ways to implement this investment strategy is to invest in Gold IRA savings accounts.

How Much of Your Portfolio Should Be Gold Denominated?

You should speak with your financial advisor for a definitive guide on how much of your investments should go to gold. The advisor will look at your existing portfolio and its composition to give you a recommendation.

However, on a general note, many analysts agree that holding 10% of your portfolio in gold is a good idea. The recommendation works because gold has a low correlation to the overall bond and stock market.

It’s also a good way to ensure your portfolio isn’t too exposed to gold price movements.

The Bottom Line on What Happens to Gold When Interest Rates Fluctuate

The price of gold can rise and fall following interest rates fluctuation. However, there is no conclusive evidence of a direct correlation between the rate changes and gold prices.

The impact of federal funds rates on gold prices comes down to the prevailing economic climate at the time under review.

Instead of paying too much attention to interest rates fluctuation and basing your gold investment strategy on it, you can adopt the dollar-cost averaging model to generate stable returns.

Timing the market doesn’t produce favorable results for the average investor.

At the Oxford Gold Group, we can teach you other ways to invest in gold outside of tracking interest rates fluctuation. We can also show you how investing in gold can improve your finances.

Call our experienced team at 833-600-GOLD to get started.

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