Gold price rallies on rate hike

gold-pour-reef-333.jpg Image of gold pour at Gold Reef City in Johannesburg, South Africa by Dan Brown.

On Wednesday on the Comex market in New York, gold futures with February delivery dates rallied from near six-year lows after the US Federal Reserve lifted interest rates for the first time in nine years.

Exchanging hands for $1,075.10 an ounce after the announcement of a 0.25% rise in rates, up 1.3% from yesterday’s close. Gold is up more than 2.5% from its lowest since February 2010 struck at the beginning of December.

Given current economic conditions, the Fed said interest interest rates are only likely to increase in a “gradual” way. The central bank has a long-run target of 3.5%.

After a strong start to the year, the increasing likelihood that the Fed would raise rates from near zero where it’s been since December 2008, has seen the gold price decline by more than 9% in 2015. The metal is set for a third straight year of declines, its worst performance since the late 1990s.

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

Higher interest rates boost the value of the dollar and makes gold less attractive as an investment because the metal is not yield-producing. As the graphs shows US Treasury yields and the gold price have a strong negative correlation and a stronger dollar has an even closer inverse relationship to commodity prices in general.

Source: Capital Economics

Source: Capital Economics

The US dollar index also jumped after the announcement to 98.55 against the currencies of the country’s major trading partners on Wednesday. The greenback has strengthened 11% over the past year and the last time the currencies topped 100 for a sustained period was in the early 2000s.

Today’s level compares to a record low of 71.6 in April of 2008 and a record high of 164.72 in February 1985 when the price of gold bottomed at $284.25 an ounce.

Oil prices moved as expected – down more than 3% to $36.10 – as the dollar rallied on Wednesday, but gold’s positive response as expectations turned to reality on rates may be an indication that with the uncertainty removed, the gold market should return to focus on fundamentals in the industry characterized by declining supply and robust physical demand.

Source: Capital Economics

Source: Capital Economics