The Correlation between Federal Interest Rates & Gold Prices
Federal interest rates have manipulated gold prices for decades. If you’re not familiar with how federal interest rates work, of if you would like to know more about how these two economic indicators can work in tandem, then pay very close attention to understand how interest rates affect gold prices. This is especially important for investors that are commodities trading, as changes in interest rates create more opportunities for gains in active market positions.
What are federal interest rates, and why do they matter?
The Federal Reserve sets the key lending rate for banks, credit unions, and other financial companies in the United States. A lower rate means that financial institutions can borrow money for less. Higher interest rates mean it is more expensive to borrow money. The interest rate that gets talked about most often is the prime lending rate, and this figure has remained at less than 1% since 2001. Interest rates are important because they have an effect on how much money the government can borrow without having to pay that money back, and interest rates affect how much consumers pay for things like mortgages, credit cards, and car payments.
What happens when interest rates fall?
When the Federal Reserve lowers interest rates, it becomes easier and more affordable to get a mortgage. Auto loans are cheaper. Stocks tend to do better when interest rates are low because companies can borrow money without having to worry about a high payback rate. Low-interest rates can cause inflation because they allow excess money to be created. That excess money could hold its value if interest rates were high, but when payback rates are just barely more than loan amounts then it becomes impossible for a currency to maintain its purchasing power.
Falling interest rates have historically been negative for gold prices in the short-term because investors are lured into stocks and real estate. The last falling interest rate cycle in the United States was from the early 1980s-2001, and during that time the gold spot price fell from $855 to $252 per ounce.
What happens when interest rates rise?
Interest rates rise when the Federal Reserve believes that inflation is more of an issue than the climate of strength in the economy. Unfortunately, inflation is often not noticeable until interest rates have already begun to rise. So even though the money supply is in the process of being tightened gold prices still rise. When interest rates rose in the 70s and 80s the gold spot price increased over 1000%. In the current cycle, interest rates have been flat but the gold spot price has increased fivefold, partly due to the anticipation of higher rates.
The gold investing market has been intertwined with the Federal Reserve’s interest rate manipulation since the inception of the Federal Reserve. Savvy gold investors should keep history in mind and keep a close eye on interest rates when timing gold investments.