Jan 30, 2007 – The Federal Reserve will soon be meeting to discuss whether to increase short-term interest rates. Most observers expect the benchmark federal funds rate to remain unchanged at 5.25%.
There are two opposing points of view about the direction that interest rates will be taking, which is always the case when it comes to markets – after all, for every buyer there is a seller. Some argue that the economy is weak and that if the Fed does anything it should be lowering rates. Others argue that inflationary pressures are building and that the Fed should be raising rates.
I’m not going to predict what the Fed might or might not do at its next meeting. But I am going to make an important observation about the impact of rising interest rates on gold.
Some are fearful that gold will drop if the Fed begins raising rates again. There’s no need to worry.
First of all, this argument ignores recent history. The Fed has been raising rates since June 30, 2004, taking the benchmark federal funds rate from 1% to 5.25% at present. During this period the price of gold climbed from $392 to current levels around $644. Doesn’t this result suggest that rising interest rates are bullish for gold?
Here’s more evidence that rising interest rates are bullish for gold. The following chart shows the yield on the 10-year T-Note from January 1962 to the present.
Note the two major long-term trends on this chart. First, the green parallel lines define a period of rising yields from 1962 through the early 1980’s, during which time gold rose from $35 per ounce to a peak around $850. But since the early 1980’s, T-Note yields have been falling, confined within the parallel red lines. During most of this period the gold price was falling, or at best, moving sideways. Again, this chart suggests rising interest rates are bullish for gold, while falling rates are bearish for gold.
It is important to note the small uptrend in yields, marked again by green parallel lines. It is another period when the gold price was rising. More importantly, this chart indicates that T-Note yields are about to break out to the upside, beginning another long-term uptrend. That event would be bullish for gold, just like rising rates in the 1960s and 70s were bullish for gold.