We now expect with some certainty that the US Federal Reserve will cut interest rates following its upcoming September FOMC meeting. What does this mean for the gold price? Is there a relationship between rates and the price of gold? In short, rate cuts are generally good for gold prices, and we explain why (in brief) below.
1. Opportunity Cost:
When interest rates are high, it becomes more attractive to invest in interest-bearing assets such as bonds, term deposits and savings accounts. These investments provide a return on investment in the form of interest payments. In comparison, gold does not pay any interest or dividends. Therefore, when interest rates rise, the opportunity cost of holding gold increases, and some investors may shift their funds out of gold and into interest-bearing assets. This can put downward pressure on the price of gold. The reverse is also true: when the opportunity cost falls, gold becomes more attractive.
2. Inflation Expectations:
Gold is often seen as a hedge against inflation. When interest rates are low and inflation is expected to rise, investors may turn to gold as a store of value to protect their wealth from the eroding effects of inflation. Conversely, when interest rates are high and inflation is low or expected to remain low, the demand for gold as an inflation hedge may decrease. After the unexpected spike in inflation post the pandemic, gold was seen as a safe haven but now that inflation is coming down, this factor in the gold price calculation appears less compelling.
3. Economic Conditions:
Changes in interest rates are driven by central bank policies, which are in turn influenced by economic conditions. When interest rates are lowered to stimulate economic growth, it can lead to increased demand for gold as a safe haven asset. Conversely, when interest rates are raised to combat inflation or overheating in the economy, it can reduce the appeal of gold.
4. Currency Strength:
Gold is priced in US dollars. Changes in interest rates can impact the strength of a currency, and a weaker currency can make gold more attractive to investors. For example, when the US Federal Reserve raises interest rates, it can lead to a stronger US dollar, which may put downward pressure on the price of gold in dollar terms. But with rates now at their peak, and the Fed committed to change its course and reduce rates, the outlook for gold is improving. In a number of countries such as Japan, China, India and Turkey, retail investors are wary of their own currencies for a multitude of reasons, incentivizing them to keep some of their assets in gold.
5. Geopolitical Risks:
Gold has been a store of value for thousands of years. It is not surprising that when geopolitical tensions are on the rise, people are attracted to gold. And there is little doubt that geopolitical tensions are heightened at present, with war in Russia / Ukraine, war in Gaza / Israel and a number of neighbouring countries, South China Sea tensions, and China / Taiwan. In addition, there are too many local and regional conflicts in the Sahel region of north and central Africa to list.
In summary, while the gold price is incredibly complex and is influenced by a myriad of factors, generally, there is an inverse relationship between interest rates and the price of gold. This means that when interest rates go down (which we are expecting), the price of gold tends to go up.
Gold in USD over 10 years
Source: FactSet, Aug 2024
