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Gold’s Greatest Increases Came When Interest Rates were….RISING
“History shows that gold prices…generally rise, though sometimes with a lag, after the first rate hike. Investors are apt to unload gold in anticipation of tightening monetary policies. This negative pressure is sustained until the Fed announces a rate hike which then eases the negative sentiment towards the yellow metal. This explains the subsequent rallies in gold that occurred shortly after the Fed announced the first rate hike in the last four tightening cycles.”
–HSBC Analyst David Bloom
Most commentaries on the gold market lately have repeated the same mantra – that gold is down because the Federal Reserve MAY soon raise rates by 25 basis points (0.25%) from near zero to a range of about 0.25% to 0.50%, which would still be among the lowest rates we’ve seen in the 100-year lifespan of the Federal Reserve. For instance, UBS said last week that gold “investors are understandably hesitant to put on sizeable positions ahead of the [Fed] meeting next week.”
The Federal Open Market Committee (FOMC) meets this week, September 16-17. If the FOMC decides to raise rates, the theory goes, gold would go down since it offers no interest, meaning that it can’t compete on an even playing field with the dollar. If the FOMC postpones its decision once again, the theory goes, gold might stage a short-term rally before falling in fear of the next FOMC policy meeting in December. If the Fed delays their decision this week, that means that U.S. interest rates would be near-zero for seven consecutive years, from late 2008 to late 2015.
This fear of interest rate hikes is misleading, since gold has usually risen when rates were raised:
Contrary to Wall Street’s commonly-recited mantra, gold has had its greatest bull markets during times of RISING rates. The two strongest bull markets in gold came from 1971 to 1980, when gold rose from $35 to $850. During that decade, the Fed Funds rate rose from 3.5% in 1971 to 15.5% in October of 1979 and then up to 20% in 1981. That may seem like ancient history – or a once-in-a-lifetime event – but gold staged another 10-year bull market from 2001 to 2011. In the middle of that rise, the Fed raised the Fed Funds rate from 1.0% in 2003 to 5.25% in 2006.
In addition, gold rose after the rate increases in December 1986, February 1994 and June 1999.
Now, let’s look at gold’s two biggest bull markets (1971-80 and 2001-11) in more detail.
Gold vs. Interest Rates in the 1970s
“Gold’s mighty secular bull of the 1970s, which greatly dwarfed the 2000s one, happened during a time of high and rising interest rates! And then gold’s subsequent multi-decade secular bear in the 1980s and 1990s unfolded during a long span of interest rates relentlessly falling.”
–Adam Hamilton, Zeal Research
Gold was fixed at $35 per ounce from January 30, 1934 to August 15, 1971, when President Nixon closed the gold window. At the start of 1971, the Fed Funds rate was 3.5%. It rose to 5.5% by the time Nixon closed the gold window. Within three years, the Fed Funds rate rose to 13% and gold rose to $154 when President Ford signed the bill which allowed Americans to own gold bullion for the first time since May of 1933. Gold then rose to $190 per ounce by late 1974.
In short, gold rose from $35 to over $150 while interest rates were rising from 3.5% to 13%.
After Americans were allowed to own gold, ironically the price went down from $190 in late 1974 to $103 in September of 1976 before taking off to reach $850 in January of 1980. During that time, the Fed Funds rate rose from 4.75% on January 12, 1976 (when gold traded at $136) to 15.5% in October, 1979, when gold was over $400. Rates hit 20% in 1981, when gold was $600.
Summary: From 1971 to 1981, rates rose from 3.5% to 20% while gold rose from $35 to $600.
The Last Time the Fed Raise Rates, Gold Nearly Doubled
From June 30, 2004 to June 30, 2006, the Fed raised the Fed Funds rate 17 times, a quarter-point at a time at 17 consecutive FOMC meetings. During that time, the price of gold almost doubled.
Rates were held at a historically low 1% from June 25, 2003 to June 30, 2004. That helped to fuel a real estate bubble with super-low mortgage rates during a time of rising stock market values and soaring real estate values. These artificially low rates may have been a factor in creating the real estate bubble that later exploded into the financial derivatives crisis of late 2008.
Under Alan Greenspan (who was Fed Chairman from August, 1987 to January, 2006), the Fed raised rates consistently at 14 straight Fed meetings. Those policies continued under the new Chairman Ben Bernanke during the FOMC meetings held on March 28, May 10 and June 29, 2006. Then, the Fed Funds rate stayed at 5.25% for over a year, until August 17, 2007. During those four years, gold nearly doubled from $346 in mid-2003 to $651 in mid-2007, up 88%.
On December 16, 2008, the Fed lowered the Fed Funds rate to a zero-to-0.25% range. On that date, gold traded at $838. Despite an interim rise to $1900 in 2011, gold is still well above its $838 level when the Fed began its ZIRP (Zero Interest Rate Policy) nearly seven years ago.
Now, with the prospect of a single 0.25% rate increase, many gold investors seem reticent to load up on the yellow metal at prices near $1,100. These fears run counter to history’s record.
History tells us that now would be a great time to load up on gold, whether or not the Fed raises rates this week (or next December). Even if the Fed raised rates 17 times in the next two years (an unlikely event), gold might surprise nearly everyone by rising 50%, or 80% or even more.
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