HedgeTalk: The Seesaw Effect of Interest Rates and Gold Prices
By: John Trefethen, Director & Co-Founder
Gold and interest rates traditionally have had a negative correlation. Though the relationship is not perfect, gold prices tend to go up as interest rates go down, and down when rates go up. In a low interest rate environment like we are currently experiencing, gold tends to attract investors seeking a “safe-haven” investment. As depicted in the charts below, in March of this year when the US Federal Reserve lowered the Fed funds rate a full percentage point to 0.25%, the yield for a benchmark 10-year Treasury bond fell to a record low of 0.62%. Gold prices then began a steady trend upward in lock-step with rates as if tethered to a counter-weight.
Further evidence of the negative correlation between interest rates and gold was made clear late last week and into this week when the 10-year Treasury yield increased 17 basis points from 0.52% on August 4th to 0.69% on August 12th. During that same timeframe, the price of gold dropped $116.25.
In theory, gold is a natural hedge for interest rate risk. However, many financial tools exist to hedge interest rate risk such as swaps, caps, floors and futures, which can be structured to more effectively manage the downside or upside risk that a risk manager is seeking to mitigate. Gold is often viewed as a hedge against broader unexpected events. These events can be macroeconomic such as the 2008 financial crisis, they can be geopolitical such as wars and terrorist attacks, or pestilence as is currently being experienced with the COVID-19 pandemic.
Since the beginning of 2020, when the seriousness of COVID-19 became more prominent, gold prices have increased approximately 25%. With the US Federal Reserve committed to keeping rates low into 2021, and with no clear end in sight of the COVID-19 pandemic, one can expect gold prices to remain at or above historical levels for the foreseeable future.