Gold price: Reasons not to fear the Fed

A number of gold market analysts have argued that the central factor influencing the price of gold is US interest rates. Some analysts go so far as to say that the inverted correlation is so strong that the gold price can be used as a predictor of interest rates, particularly after adjusting for inflation.

What has now almost become a rule of thumb is that rising real interest rates raises the opportunity costs of holding gold because the metal provides no yield and therefore the price should decline. Higher rates also boost the value of the dollar which usually move in the opposite direction of the gold price.

Since the global financial crisis the relationship between interest rate expectations and the gold price has only become tighter with some analysts believing that the metal can serve as an early warning system of both the direction and magnitude of the move in rates.

Don't fear the Fed

Source: Capital Economics

A new research note from Macquarie, an Australian bank and commodities traders, quoted by Kitco News makes the case that the first rate hike by the US Federal Reserve in nine years expected later this, won't necessarily be negative for gold.

“On the 31 occasions the Fed has raised rates since 1994 (the date after which it first made its decisions public) gold has gained slightly more often than it has fallen in price,” they said in the note. The last time the central bank raised interest rates, June 29, 2006, they said that gold rallied 3% on the day. Of course they admit that this result was an outlier.

“It might be argued that the rate hike in June 2006 was the culmination of a rate tightening cycle, and indeed at the time press reports attributed a rally in equities and gold to a sense of relief that the rate hikes were now over. A rate hike in September 2015 will be the start of a cycle,” they said. “However even if we separate the rate hikes at the end of a cycle from those at the start of a tightening cycle there seems no discernible impact.”

A note from Capital Economics, an independent research house, acknowledges the negative relationship between rates and gold but adds that "this link can be overdone":

"Note first that it is a question of degree. An eventual rise in annual US interest rates to, say, 4%, would not have a huge impact on the relative attractiveness of holding gold, given its value as insurance against extreme events and the scope for prices to move by significantly more than 4% in a relatively short period.

"Suppose, for example, that the Fed is tightening policy because US inflation is picking up. In this case there may actually be increased demand for gold as an inflation hedge.  Alternatively, suppose that Fed tightening triggers a sell-off in other asset markets, including equities as well as bonds. This may well increase demand for gold as a safe haven."

ETF Securities, a specialist investment company that created the world's first gold exchange traded commodity, also point out in their latest report that despite Fed tightening rhetoric, market tightening expectations have been declining:

"At the beginning of 2015, December 2015 Fed Funds Futures were priced for about 50 basis points (bps) of tightening. At the end of May, December Fed Funds Futures had reduced 2015 tightening expectations to about 20 bps."

Don't fear the Fed

Source: ETF Securities