There we go again: gold investors are panicking as the price of gold dives lower.
Admittedly, the technical picture does not look very constructive. However, we have to put this into perspective. Gold in dollar terms may be under pressure, but gold in euro terms does not look that bad, on the contrary in fact.
Gold in euro is setting a chart pattern of higher lows and higher highs in the last couple of months. Even its 50 day moving average seems to be trending positively.
This picture is similar for most currencies, except the dollar.
However, the focus of the market is on gold in dollar, as the market is concerned about an interest rate hike, based on the ‘narrative’ that a rate hike is bad for gold.
But is this narrative correct? It wouldn’t be the first time that the herd is proven wrong.
Contrary to the ‘pundits’ and ‘writers’ who make statements that the crowd wants to hear, we underpin our investigation based on historic facts and figures. In particular, we analyzed gold’s reaction after interest rate hikes in the last decades (as of 1972, when gold started to trade freely).
You will be surpised about our findings!
The first increase of the Fed Funds Rate (the official term for interest rates, used by the Federal Reserve) took place between February 1972 and July 1974.
As you can see on the above chart, gold rose from approx. 40 USD/ounce to 180 USD/ounce (x 4!), as the interest rate increased from 3 to 13%.
The next period of interest rate hike(s) was between June 1977 and March 1980, which was a time characterized by an exceptionally high inflation rate.
Once again, the price of gold went sharply higher, from approx. 100 USD/ounce to 800 USD/ounce: an 8-fold increase!
That period was very volatile, as the Fed brought interest rates sharply down after peaking. Because of that, and the fact that inflation remained stubbornly high, the Fed had to increase rates between July 1980 and January 1981.
Gold remained in a trading channel, between 600 and 700 USD/ounce, which indicates that gold had ‘sniffed’ the fact that inflation was moderate.
Soon after, inflation started to soften, which gave the economy a significant boost. In that time period, the Fed intervened several times to avoid an economic overactivity.
The next interest rate hike took place between February 1983 and September 1984.
As of then, gold lost significant value: the price of the yellow metal declined from 500 to 350 USD/ounce, as the interest rate rose from 8.5% to 11.5%. Note that those were still relatively high interest rates, given historical averages, which points to the fact that centrale bankers were still concerned about inflation.
The next period of interest rate hikes is between September 1986 and April 1989.
Initially, the gold price reacted positively, as it rose from 400 to 500 USD/ounce, but as the central bank pushed interest rates aggressively higher in the second half of that period, the price of gold declined again to 400 USD.
That brings us to the 90’s, a decade which was characterized by economic prosperity and low inflation. The first interest rate hike took place between December 1993 and June 1995.
This is another period which wasn’t negative for gold, in the context of a rate hike, as the metal remained in a trading range between 375 and 395 USD/ounce.
Towards the end of the 90ies, the Fed had to intervene again to avoid a large scale economic heating driven by the technology boom.
In a matter of 1.5y, the interest rates almost doubled, but gold remained basically moving in a trading range between 250 and 330 USD/ounce.
After the dotcom bubble bursted, the Fed only started hiking rates again as of May 2004 until July 2006.
And right at the moment truly nobody believed gold would ever recover, the price of the metal rallied significantly during the second part of that period from 400 to an intermediate peak of 700 USD/ounce.
The above discussed periods highligh the most significant interest rate hikes after gold started to trade freely in August of 1971.
What can we learn from this?
- 3 periods with a positive impact on the price of gold
- 2 periods with a negative impact on the price of gold
- 3 periods in which gold traded sideways
That being said, how can any serious person conclude that gold will, without any doubt, trade lower in the next interest rate cycle? Statistically, we just proved that it was the case in only 2 of the 7 instances.
Moreover, the two periods in which gold was negatively impacted by interest rate hikes happened after a period of exceptionally high inflation.
When the economy was booming while disinflationary, gold remained flat with interest rate hikes. A well chosen entry point in a gold investment gave a very interesting yield.
That brings us to today. If the Fed is going to engage in a new interest rate cycle, they will do so to control rising inflation.
As we are exiting a period of exceptionally low interest rates with a moderate economic growth, present times are comparable to the time period 2004 to 2006.
As interest rates rose during those years, the price of gold followed that path higher as of the moment the Fed engaged in a monthly rate hike. During the last phase of rate hikes, gold started to rise even exponentially.
We believe that this path will be repeated in the future. We will most likely see a pattern of higher lows and higher highs, as gold’s decline is about to stop when they hike.
We do not anticipate a spectactular rally in the short term as that is typically a move that unfolds in a later stage of a bull market. Also, it goes hand-in-hand with rising inflation concerns. Astute investors know this is a time to be accumulating the precious metals, not fleeing it.
Secular Investor offers a fresh look at investing. We analyze long lasting cycles, coupled with a collection of strategic investments and concrete tips for different types of assets. The methods and strategies are transformed into the Gold & Silver Report and the Commodity Report.
First published here: http://www.zerohedge.com/news/2015-11-19/how-gold-acted-during-past-rising-rate-cycles