Gold and Interest Rates: Are Changes in the Federal Funds Rate a Good Predictor of Gold Prices?

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(H/T GoldSeek.com)

By Arkadiusz Sieron

Teaser: Many investors believe that the federal funds rate is adversely related to the gold price. Interest rate cuts are perceived as a sign of cheap money policy – a bullish signal in the gold market. Similarly, the rise of the federal funds rate is considered as detrimental for gold prices. However, it seems that real interest rates are more important than nominal ones. Are changes in the federal funds rate a good predictor of gold prices, then?

Gold and Federal Funds Rate

Many investors believe that the federal funds rate is adversely related to the gold price. Interest rate cuts are perceived as a sign of cheap money policy – a bullish signal in the gold market. Similarly, the rise of the federal funds rate is considered as detrimental for gold prices. Recent events are the best example. The last drop in the gold price was contributed to by expectations of faster hikes of the federal funds rate. Although this relationship may often hold, investors should be skeptical about this rule of thumb. There are many cases when an increase in this rate was accompanied by parallel moves in the price of gold. From 1971 through 1974, the federal funds rate rose from 5 to 10%, while the gold price flew from $35 to $200 per ounce. Similarly, between summer 2004 and 2006 the funds rate soared from 1 to 5.25%, while the gold price rose from $400 to $700.

Graph: Gold price (red line, right scale) and effective federal funds rate (blue line, left scale) from 1970 to 2014

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