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Interest Rates and Gold: What You Need to Know
By Stephanie Colestock MONEY RESEARCH COLLECTIVE
Historically, the value of gold and U.S. interest rates have had an inverse relationship with one another, rising and falling on opposite waves. As interest rates climb, gold prices tend to fall… and vice versa.
Why does this happen? What does it mean for investors and consumers looking to maximize investment returns and minimize interest rates? Here’s everything you need to know.
Gold as an investment
Gold has been valued and collected by societies for as long as we have written record, with the first mentions of it coming out of Egypt around 2600 BC. Whether you’re investing in gold futures, storing bullion in your safe, or wearing it around your neck, the value of gold is considered a safe-haven asset.
This means that the value of gold is resilient and acts as a hedge against inflation, protecting investors’ portfolios from volatility and even serving as a benchmark for the value of other assets. While other investments and commodities can fluctuate wildly in value due to supply and demand or inflation, the price of gold tends to remain relatively steady.
Gold values are driven by real rates, which are nominal interest rates minus inflation, and typically rise when inflation is high and interest rates are low. Essentially, gold tends to be most valuable when fiat currencies and the economy as a whole are at their weakest, such as during a recession.
How is gold traded?
There are a few different ways to hold and trade in gold, depending on your personal preferences.
- Physical gold: Investors can purchase gold bullion, bars, coins, and even jewelry. This offers a tangible asset that you can store wherever you like, though it does have the potential for theft.
- Gold-backed securities: Investments like exchange-traded funds (ETFs) and mutual funds allow you to trade in shares on the stock exchange the way you would any other investment. These investments track the price of gold or may even invest in the gold mining industry. Gold futures and options also allow investors to buy and sell gold securities at lucrative prices as prices rise and fall.
- Gold certificates: These represent ownership of gold without the hassle of physical possession. They act as an IOU that can be traded or exchanged for physical gold in the future.
Gold investments can be held in retirement accounts (like gold IRAs) or even gold-backed savings accounts through select financial institutions.
The basics of interest rates
Interest rates are simply the cost of borrowing money. Expressed as a percentage, interest rates are set by banks and other financial institutions on everything from loans and credit cards to savings accounts earning a return.
Bank interest rates are based on central bank benchmark rates, which are published by the Federal Reserve. In addition to influencing borrowing costs, these rates influence consumer spending trends and play a direct role in both fiat currency strength and inflation.
While not a set rule, higher interest rates tend to lead to more constrained consumer spending. This in turn can lead to lower stock prices and investment returns.
Interest Rates and Gold Prices
As mentioned, interest rates and gold values tend to have an inverse relationship with each other.
There is an opportunity cost involved with owning and holding gold since it is not an interest-bearing asset. In fact, gold is often a poor investment when the economy is strong, as high interest rates correspond with increased earnings. This means that gold is less attractive when interest rates rise, as investors could likely earn higher returns by investing their money elsewhere, such as stocks and government bonds.
On the other hand, low interest rates may raise the demand (and therefore, the price) for gold, since its value remains stable even as volatile and interest-bearing investments plummet. While investors may scramble to net returns elsewhere, gold values remain a strong constant.
Historical Trends
Seeing the historical relationship between low gold values and high interest rates, or surging gold values amid times of high inflation and low rates, is pretty easy.
In the 1970s, for example, the United States experienced what’s called “stagflation,” which was a period of high inflation, low interest rates, and uneven economic growth. While most of the country was in wild flux — and the value of the US Dollar plummeted — gold values surged by as much as 72.5% in a single year.
The 2008 Great Recession financial crisis is another example of gold’s strength in value. Following the housing market collapse, banks slashed interest rates in an effort to stimulate the economy, with the Federal Reserve even going as low as 0% in an unprecedented move. Investors found themselves flocking to stable investments in the fallout of the financial collapse, with gold being a strong front-runner. In fact, the value of gold hit its then-highest value in 2008 and the years that immediately followed.
Even if you weren’t paying attention (or alive) for either of those events, you may have seen the effects of the COVID-19 pandemic on gold and interest rates. Throughout 2020 and 2021, investors and consumers worldwide felt the pinch of the pandemic. Job losses and unemployment levels rocketed, the stock market bottomed out, and certain interest rates (like home mortgages) dropped to never-before-seen levels. As you might expect, gold was the strong performer then, too, hitting yet another all-time high value (to date) and giving investors a stable place to park their cash.
Investing in gold (no matter what interest rates are doing)
If you want to invest in gold — either at a small scale or by diversifying your portfolio — there’s never a “bad” time. Gold can be a wise part of any balanced investment portfolio and stable diversification strategy. However, you may want to adjust your strategy at any given time, depending on how the economy and interest rates are performing and what that means for gold prices.
When interest rates are rising, gold tends to be a more attractive (and more affordable) purchase option. You might consider using this opportunity to purchase either gold assets or securities at competitive prices.
When interest rates are falling or low, gold is usually a more steady and valuable asset, and its price often rises to reflect that. You can still invest in gold, especially if it’s to hedge your portfolio with a stable investment, but focusing on other investments may make more sense at that time.
In summary
There is no guaranteed relationship connecting gold and interest rates, though history has shown a pretty reliable inverse correlation between the two. When interest rates are low and inflation creeps up, gold prices tend to remain steady or even grow. And even as interest rates rise and other investments look more enticing, gold remains a safe-haven asset with a strong value that can hedge any well-diversified portfolio.
As with any investment, buying and selling gold requires you to understand this inverse relationship and watch for markers that indicate a movement in gold pricing. This means watching current market conditions, tracking interest rate trends, and even keeping an ear out for anticipated Federal Reserve announcements.