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I've seen articles explaining that rising interest rates are bearish for
gold and I've seen articles explaining that rising interest rates are bullish
for gold, so which is it? Are rising interest rates bullish or bearish for
gold? The short answer is no - rising interest rates are neither bullish nor
bearish for gold. Read on for the much longer answer.
I'll begin by noting what happened to nominal interest rates during the
long-term gold bull markets of the past 100 years. Interest rates generally
trended downward during the gold bull market of the 1930s, upward during the
gold bull market of the 1960s and 1970s, and downward during the gold bull
market of 2001-2011. Therefore, history's message is that the trend in the
nominal interest rate does not determine gold's long-term price trend.
History tells us that gold bull markets can unfold in parallel with rising
or falling nominal interest rates, but this shouldn't be interpreted as
meaning that interest rates don't affect whether gold is in a bullish or bearish
trend. The nominal interest rate is not important, but the REAL interest rate
definitely is. Specifically, low/falling real interest rates are bullish for
gold and high/rising real interest rates are bearish. For example, when gold
was making huge gains during the 1970s in parallel with high/rising nominal
interest rates, real interest rates were generally low. This is because gains
in inflation expectations were matching, or exceeding, gains in nominal
interest rates (the real interest rate is the nominal interest rate minus the
EXPECTED rate of currency depreciation). Also, the 2001-2011 bull market
occurred in parallel with generally low real interest rates.
Very low real interest rates are artifacts of central banks. In the US,
for example, the Fed's actions ensured that the real short-term interest rate
on "risk free" (meaning: no direct default risk) debt spent a lot
of time in negative territory during the 1970s and during 2001-2011. In
effect, "very low real interest rates" means "excessively loose
monetary policy".
Something else that affects gold's price trend is the DIFFERENCE between
long-term and short-term interest rates (the yield-spread, or yield curve),
with a rising yield-spread (steepening yield curve) being bullish for gold
and a falling yield-spread (flattening yield curve) being bearish. It works
this way because a rising trend in long-term interest rates relative to
short-term interest rates generally indicates either falling market liquidity
(associated with increasing risk aversion and a flight to safety) or rising
inflation expectations, both of which are bullish for gold.
As is the case with the real interest rate, under the current monetary
system the yield-spread tends to be a symptom of what central banks are
doing. If money were sound and free of central bank manipulation, then the
yield-spread would spend most of its time near zero (the yield curve would be
almost horizontal) and would experience only minor fluctuations, but thanks
to the attempts by central banks to 'stabilise' the markets the yield-spread
experiences huge swings. For example, the following chart shows the huge
swings in the US 10yr-2yr yield-spread since 1990. The periodic up-swings in
this chart were generally due to the Fed exerting irresistible downward pressure
at the short end of the curve while the discounting by the market of currency
depreciation risk caused interest rates at the long end to be 'sticky'.
 
Last but not least, gold is influenced by the economy-wide trend in credit
spreads (the differences between interest rates on high-quality and
low-quality debt securities). Gold, a traditional haven in times of trouble,
tends to do relatively well when credit spreads are widening and relatively
poorly when credit spreads are contracting. This is because widening credit
spreads typically indicate declining economic confidence.
If the three main interest-rate drivers (the real interest rate, the
yield-spread and credit spreads) are gold-bullish then there's a high
probability that gold will be in a strong upward trend in terms of all
currencies and most commodities. By the same token, if the three main
interest-rate drivers are gold-bearish then there's a high probability that
gold will be in a strong downward trend in both nominal and real terms. However,
it's not uncommon for the interest-rate conditions to be mixed. The past year
is a good example of a mixed interest-rate backdrop for gold in that during
this period the credit-spread situation was generally gold-bullish (credit
spreads were widening) while the real interest rate and yield-spread trends
were generally gold-bearish. The net effect of this interest-rate backdrop
was slightly bearish for gold.
In summary, gold benefits from low/falling real interest rates, an
increasing yield-spread (a steepening yield curve), and widening credit
spreads, each of which can occur when nominal interest rates are rising or
falling. You can therefore ignore the "rising interest rates are bearish
for gold" and the "rising interest rates are bullish for gold"
arguments. The relationship between gold and interest rates is not that
simple.
http://tsi-blog.com/
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