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Interest rates are rising. What does this mean for gold?

Gold prices soared in 2020 as the US Federal Reserve cut rates and the US government prepared unprecedented stimulus packages. Now with interest rates on the rise, will gold fall further? And how far?

Source: Bloomberg

Note: all valuation references are for US dollars per troy ounce of gold

As the pandemic spread in 2020, threatening a recession, the US Federal Reserve lowered interest rates (the Federal Funds Rate) to 0-0.25% in March 2020. Importantly, this dragged the benchmark 10-year Treasury note yield down to a record low of 0.52% on 4 August 2020.

Gold soared, jumping from $1,519.50 at the end of 2019 to a peak of $2,038.08 on 5 August 2020.

Gold prices typically rise as interest rates fall: the relative attraction of gold rises as earned interest goes to zero.

The opposite holds for rising interest rates. Earning 0.1% in a bank account isn’t very enticing. With banks now offering up to 3.35% for one-year term deposits, cash is regaining its attraction compared to gold.

Gold prices have taken a tumble

The Federal Reserve – and other central banks such as the RBA – began raising interest rates in March 2022. Gold fell from its high of $2,052.60 on 8 March to $1,773.30 on 4 August 2022.

This 14% correction is significant for any asset class. But a brief look at history shows how far gold prices can fall before embarking on the next bull market.

You don’t have to look far. A similar situation arose after the 2008 banking crisis when the Federal Reserve dropped interest rates to the zero to 0.25% range.

Last time gold peaked, it fell by 41%

Between September and December 2008, the Federal Reserve dropped interest rates from 2.0% to 0.15%. The yield on the 10-year note fell over time from 3.97% at the start of August 2008 to below 2% in September 2011.

Gold embarked on a 3-year bull market from $833.6 on 31 August 2008 to $1,896.5 on 5 September 2011.

The 10-year note yield traded generally below 2% until April 2013. Then yields rose again and remained generally above 2% through December 2015.

Gold remained above $1500 for 24 months from May 2011 to April 2013. It then entered a bear market and bottomed at $1,049 on 17 December 2015.

During the bear market, gold fell 41% over 3 years: from the beginning of the correction at $1,790 on 5 October 2012 to the bottom of $1,049 .

Could it happen again?

The most recent peak before the beginning of this bear market was $2,052.6 on 8 March 2022. If this bear market/correction were to mirror the 2014 bear market, the gold price could fall to $1202 over the next 36 months.

This is not to suggest that history will repeat itself, especially as there are two key differences today.

First, the 2014 correction was during a period of close to zero interest rates where the yield on the ten-year US Treasury note traded in a narrower yield range between 1.37% and 3.1%. The rise this time has been much further and faster, from 0.55% in August 2021 to as high as 3.43% last month.

Second, the Federal Reserve has created a lot more currency through quantitative easing, which means reining in the liquidity could have an even larger impact on the market.

Nevertheless, if the above assumptions and analysis are correct, and if gold prices repeat what they did last time, a bet on falling gold prices could reap a handsome reward.


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