Are Rising Interest Rates Bad For Gold?

Written by Chris Marcus for the Miles Franklin blog

A legitimate concern to gold investors that’s often raised is whether rising interest rates are bad for gold prices.

Because if we were in the midst of a typical Federal Reserve tightening cycle where the money supply was being contracted, theoretically the prices of precious metals should drop.

Yet the times we live in are anything but typical, and given the context of what’s going on, the current Fed policy actually comes as great news to those who own gold.

Primarily because the past decade of central banking actions has inflated bubbles that are even bigger this time around. And that are seemingly less well equipped to handle higher interest rates than ever before.

So if the Fed continues raising rates until the bubbles pop, we aren’t looking at a typical tightening cycle where things carry on as normal.

Leaving aside the incredibly likely probability that the Fed would respond in this scenario with a money printing campaign that would make the previous quantitative easing programs pale in comparison, even without that occurring there’s a lot of reason to believe there would be a spike in demand for gold.

Remember that historically one of the primary appeals of gold was to protect against systemic risk, market chaos, and currency devaluation. Yet over the past 7 years in particular as these conditions have been further exacerbated while the metals have languished due to the suppression of the market, it’s almost been easy to lose track of how gold should be trading.

But keep in mind that if rates go up and the bubbles pop, that means a lot of investors are selling other assets. Which frees up investment capital for a precious metals market that is highly under subscribed at this point. And given the type of market chaos that has almost been guaranteed by the economic and political actions that have taken place, the incentive for investors to buy gold as insurance is greater than ever.

It’s also worth considering that even if the Fed really did contract the money supply and somehow the bubbles stayed in tact, gold would still likely rise based on how much catching up it has to do in price.

While there is ample room to discuss which money supply measurements and precious metals data to actually use, there is a simple method that in the very least puts into perspective how much catching up gold likely has to do.

In August of 2008 gold was trading around $820 per ounce. While the monetary base was at $875 billion. Currently the monetary base is approximately $3.7 trillion dollars (has more than quadrupled) while gold sits around $1,300 per ounce, up slightly over 50%. Meanwhile the stock markets are also up by multiples, while real estate has soared past 2007 highs in many areas around the globe.

So I would assert that even if the money supply were contracted significantly, gold would still be well undervalued. Then add in that The Department of Defense and The Department of Housing and Urban Development have “lost” $21 trillion, and you have to at least consider that we really have no idea how much money is actually out there.

Of course if the money supply did contract significantly (no, I don’t consider a massive balance sheet and still sub-2% interest rates a decade later a legitimate tightening), I can’t come up with a way that the system would still be in tact. And in that case, again I would certainly want gold or silver versus dollars or treasuries.

When I first started researching the gold market in 2009 this was one of the conclusions I quickly reached. That it’s past the point of no return. That whatever the Fed does is ultimately irrelevant from a long-term standpoint.

Yes, they can and have delayed the inevitable. Although should they stay on course with their tightening policy, it still leads to the same outcome. Which is why I always felt so comfortable owning gold and silver. Whatever the Fed does, the outcome is ultimately beneficial to having metal over U.S. paper.

Perhaps in some sort of normal world things would be different. But the Fed tightening leads me to believe that we are just approaching the break point sooner than had they left interest rates at 0%.

So while some may look at the rising interest rates and think that’s a reason to exit the precious metals markets, putting the situation in context offers great reason to believe that even if rates continue going up, eventually so will gold.

–Chris Marcus

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