Page 77 - MEX-Yearbook-2017

Myths 1: Rising interest rates pressurizes
metal prices.
There is always a strong negative correlation
between interest rates and gold price. When
interest rate increases, the return on the other
financial assets increase but as gold does not
provide such returns, the opportunity costs
for holding it increases. Hence, the demand
will decrease and so the price of gold falls.
Similarly, lower Fed interest rate on cash and
bonds coincides with the greater attraction of
gold on an investment.
However, there is a big misconception that
interest rate hike results in the weakening
of gold. Higher interest rates are not
unconditionally adverse for gold.
Myth 2: Interest rate is the only factor that
affects gold price
Choosing a specific factor for the change in
the price of gold will render an incomplete
analysis. Searching for just a single or an
ultimate factor – Fed interest rate policy for
determining gold’s price, results in failure.
Other factors in addition to Fed interest rate
policy plays a significant role in gold price
determination. The price of gold is not just
a function of interest rate but other factors
including unemployment rate, inflation rate
and historical convention of demand and
supply among others. Normally, the basic
commodities price is the function of demand
and supply in the long run and so does gold.
However, recent trends show that the demand
is the stronger component between the two.
Reviewing US Interest Rate & Gold Prices
Gold price reveals the US economic health.
When gold price is high, it indicates that the
economy is unhealthy, as investors buy gold
as protection from some economic crisis.
Gold Close Price
The US recession began in December 2007 and
ended in June 2009. The interest rate before
the recession touched its peak of 5.26 percent
in 2007 which facilitated the recession. US
Federal Reserve then worked on reducing the
rate and dropped it to less than 1 percent in
2009. The Fed fund slumped to the all-time
lowest of 0.25 percent in December 2008.
The immediate and cautionary step taken by
the Federal Reserve helped to recover from
the recession. In February 2009, gold price
rose above $1,000 per troy ounce as investors
piled into gold to preserve wealth amid the
tumbling stock market.
The gold price had touched it peak of
$1,917.90 per troy ounce on August 22, 2011.
The qualms after Morgan Stanley warned
that the US and Europe were dangerously
close to a recession caused the gold price to
rise. Debt issue in the US and Europe were
playing a huge role in investors buying gold.
However, after reaching the peak point, gold
price slowly started to decrease and till date
never again has touched that peak level.
From December 2008 till December 2015, for
around seven years, the Fed rate was fixed
at 0.25 percent. The rate was deliberately
dropped after the steps taken by the Federal
Reserve to overcome the recession. At that
time, the gold price fluctuated suggesting that
even if Fed rate is constant, the gold price
will change. This provides enough evidence
for the readers to believe that Fed rate is a
necessary but not a sufficient condition for
the change in the gold price. Upon scores of
robust data and reports which indicated the
reversal of the fortunes of the US economy,
the Fed rate hiked to 0.5 percent on December
2015.
Recent Scenario
The Federal Reserve raised the federal funds
rate to 1.5 percent during its December 2017
declaration. The meeting had concluded that
the labor market has continued to strengthen
Fed Rate
and the economic activity has been rising at
an accelerating pace.
As investors braced for an expected US
interest rate increase, along with getting clues
about further hikes from the Federal Reserve,
gold price recoiled to a near five-month
low on 11 December 2017. The gold prices
have tumbled in December 2017 depicting
the market anticipation of the interest rate
hike and its negative impact on the gold
price. However, despite the action which
was against gold attractiveness, the price
rose on 13 December. Analysts suggest that
weakening of US Dollar due to unchanged
projection of interest rate hike supported the
gold price.
Decoding Fed Interest Rate Rise in 2017
Reason 1: US Unemployment Rate had
displayed a stable decline in 2017. As per
the data published by the US Bureau of
Labor Statistics, the unemployment rate for
October was just 4.1 percent. This indicated
improvement for the US economy.
Reason 2: US Inflation Rate had not
significantly improved along with declining
levels of unemployment. The Fed’s target
rate was 2 percent but the actual inflation
rate remained below than that which is one
of the basis for Fed’s decision for interest
rate hike. The inflation rate for September
was 1.7 percent which improved by 0.1
percent in October, which was the highest in
6 months and indicated that the economy was
recovering.
The fluctuation of gold price even when the
Fed rate was constant has provided a basis for
investors to understand that not just the Fed
interest rate, but other factors like general
supply and demand, unemployment rate,
inflation rate, equity prices and volatility
and US dollar are the drivers of the price of
gold. However, when the Fed steps onto the
dais and is on the verge of proclaiming the
Fed Funds Rate, the whole world sits up and
watches!
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