Page 76 - MEX-Yearbook-2017

Research Paper & Articles

Gold & US Rates:

An Important Yet Complicated Relationship!

Prerana Bhattarai Historically strong relationship seemed to break! The recent
(The author is associated in the capacity of Trainee Junior rise in the Fed Fund Rate after the improvement in the
Officer in the Research & Development Department of employment rate and inflation rate has caused the price of
Mercantile Exchange Nepal Limited. She is also a part gold to rise.
of the Editorial Team of the MEX Year Book. She can be Historically, whenever the Fed raises the interest rates, the
contacted at r&d@mexnepal.com) US Dollar strengthens and the demand for gold, which is a
dollar-denominated commodity, tends to decrease. Being a
75 | MEX NEPAL YEAR BOOK 2017 non-interest-bearing commodity, it does not provide income
like dividend and interest, as a result investors are attracted
towards other interest bearing securities. Hence, whenever
the Fed interest rate increases, the value of gold drops.
However, when interest rate falls, gold becomes one of the
best investment alternatives.
Basically the major reasons for investing in gold are as
follows:
• Investors in the capital market face volatility as there are

perpetual movements in the market. However, investing
in gold is a safe haven as it retains its value despite the
market turbulence. Gold has been considered as a store
of value as it serves as a form of insurance over a period
of time. Any adverse event in the US economy drives the
investors to gold, which tend to drive its price.
• In the long run, the yellow metal provides a hedge against
inflation.
• The bullion has always been considered as the best
investment alternatives and when stock markets decline
significantly, investors consider parking their money in
gold.
The Fed Funds Rate is the interest rate that banks charge
each other to lend the central banks fund, Federal Reserve.
The central bank of the US uses the Fed Funds Rate as a
tool to control the US economic growth which makes it
the most important and widely watched interest rate in the
world. Banks use the Fed Funds Rate as a base rate to all the
short-term interest rates like LIBOR and the US prime rate.
Similarly, longer term interest rates are indirectly influenced.
In a dynamic market, even historically strong relationship
does not hold relevance every single time. With the passage
of time, the scenarios change as well. Hence, considering the
historical relationship to be true always, is a blunder. In the
market, there are presumptions about the correlation between
the Fed interest rates and the price of gold that is always
assumed to be true. Some major myths are as follows: