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Many investors purchase gold in the hopes that it will remain stable in an uncertain market. But what happens to gold when interest rates fluctuate? Does it truly remain stable, or does its value change? Our experts at Oxford Gold Group explain what you need to know about gold and interest rates during times of inflation to build a diverse investment portfolio.
Interest Rates’ Impact on Gold
Interest rates are, essentially, the price a lender charges a borrower for a loan. Typically, interest rates are a percentage of the total loan amount.
The federal funds interest rate is the target rate that the Federal Open Market Committee sets for banking and borrowing needs. This rate may rise or fall depending on economic circumstances.
When Interest Rates Rise
Interest rate hikes typically occur when the economy sees growth. As the economy improves, more people can afford loans for houses, cars, and other big purchases. This means that banks and other lenders can make more money off of those loans, so they increase interest rates.
In addition, interest rates may rise because of inflation. High interest rates may encourage people to save rather than spend, which can help drive down costs.
Rising interest rates aren’t just good for lenders; they can also be beneficial for investors. Many investors choose to take advantage of the opportunity to purchase stocks and other assets — which, in turn, causes the dollar’s value to increase.
But what happens to gold when interest rates fluctuate? Precious metals like gold are safe havens against market instability. When the dollar’s value goes up, investing in gold no longer seems necessary, and so its overall value tends to go down.
Essentially, when the value of the dollar goes up, the price of gold goes down.
When Interest Rates Fall
While a thriving economy encourages high interest rates, a struggling economy has the opposite effect. Poor economic growth results in falling interest rates. As such, many may turn back to gold for security, driving up the price.
Gold often has a negative correlation to interest rates: When interest rates fall, gold’s value rises.
Factors Influencing Changes in Interest Rates
Countless outside factors affect both fluctuating interest rates and gold prices, including the current state of the economy, governmental policies, and supply and demand, among other things. That said, the general state of the economy often has the biggest effect on changing interest rates.
Value of the US Dollar
The US dollar is relatively stable; it plays a major role in the world’s economy, so it has maintained value over time. Fluctuations in the economy can still affect the US dollar’s value. As the economy grows, the dollar’s value rises, and so will interest rates. If the economy struggles, however, the dollar’s value — and, in turn, interest rates — will fall.
Demand for Gold
The demand for gold may not directly impact interest rates rising, but it’s still connected. As interest rates fall, the demand for gold often rises since investors feel more confident in gold’s stability. Increasing demand will increase gold’s overall worth.
Gold Production
The amount of gold that mining companies produce can affect whether gold’s value rises or falls, which can influence interest rates. As supply increases, the price of gold goes down. When gold is cheap, many investors may turn to it as an investment, prompting the Fed to adjust interest rates.
Historical Analysis of Gold Prices in Relation to Interest Rates
Gold’s negative correlation with interest rates is a relatively recent development. Throughout history, what happens to gold when interest rates fluctuate? In the 1970s and 1980s, gold prices and interest rates seemed to rise together.
Between 1971 and 1980, interest rates skyrocketed, rising from 3.5% to 16%. Gold prices also rose significantly during this time, jumping from $50 per ounce to $850 per ounce.
Rising gold costs and interest rates remained strongly linked through the 1970s and 1980s. Between 1973 and 1974, gold prices and interest rates rose in tandem; between 1975 and 1976, both interest rates and gold prices stagnated. Both started rising again in 1978 and then declined during the 1980s.
It wasn’t until the 2000s that the negative correlation between the two first appeared. In 2001 and 2002, interest rates started to fall — but unlike in the 1970s and 1980s, gold prices rose. This trend continued throughout the 2000s and 2010s, with prices fluctuating between 2007 and 2008, 2009 and 2016, and 2017 and 2018.
However, these fluctuations weren’t entirely consistent. Between 2005 and 2006, both gold prices and interest rates rose together. Between 2009 and 2016, gold prices fluctuated wildly, regardless of whether interest rates rose or fell.
More recently, gold prices and interest rates both went up during 2019 and 2020.
What Drives Gold Prices?
While gold prices and interest rate fluctuations seem connected, their history shows that this isn’t a consistent trend. Supply and demand more directly drive gold prices.
The principle of supply and demand dictates that the less there is of a commodity and the more people want it, the higher the price will rise, and vice versa. Gold is a finite resource, and that limits the amount in circulation, causing prices to rise.
Conversely, if someone builds a new gold mine, then supply will increase and gold prices may drop. That said, it generally takes about 10 years to establish a gold mine, so it may take a while to see the effects of increased gold supply on the market.
Demand has a much greater effect on the price of gold and is the major reason gold prices may see an increase when interest rates fall. Falling interest rates cause investors to turn to safe-haven assets like gold, which increases demand — and, therefore, its price.
Evaluating Gold’s Hedge Against Modern Inflation
High inflation can be a concern for many investors. Because of this, many people want to find investments that will remain stable even as the economy changes.
Thankfully, gold remains a reliable hedge fund against inflation. The precious metal is generally in high demand, can be liquidated easily, and doesn’t have credit risks, among other advantages.
To get the most out of gold, however, you’ll generally need to hold onto it long term. Speak to a financial advisor to learn about your options for long-term gold investments, including gold IRAs.
Balancing the Gold Percentage in Your Portfolio
While having gold in your investment portfolio can be advantageous, the ideal amount of gold varies. Many investors recommend building your portfolio with 10% gold; this is a large enough amount to reap the benefits of investing in gold but not so large that economic fluctuations would disrupt your investment strategy.
In addition, it’s generally best to invest in gold before demand starts to rise. Ideally, this means investing just before interest rates begin falling; doing so would allow you to purchase gold for a cheaper price but also allow you to enjoy the benefits quickly. Ultimately, though, it’s best to speak to an advisor to determine when to purchase gold — and how much to buy.
Oxford Gold Group offers a range of gold products to choose from, from gold IRAs to coins. Learn more about what happens to gold when interest rates fluctuate or how to buy gold by calling 833-600-GOLD.
