What is the relationship between interest rates and gold?

The relationship between interest rates and the price of gold is complex and can be influenced by a variety of factors. Generally, there is an inverse relationship between interest rates and the price of gold. This means that when interest rates go up, the price of gold tends to go down, and vice versa.  We discuss how this relationship works below:

1. Opportunity Cost:

When interest rates are high, it becomes more attractive to invest in interest-bearing assets such as bonds and savings accounts. These investments provide a return on investment in the form of interest payments. In comparison, gold does not pay any interest or dividends. Therefore, when interest rates rise, the opportunity cost of holding gold increases, and some investors may shift their funds out of gold and into interest-bearing assets. This can put downward pressure on the price of gold.

2. Inflation Expectations:

Gold is often seen as a hedge against inflation. When interest rates are low and inflation is expected to rise, investors may turn to gold as a store of value to protect their wealth from the eroding effects of inflation. Conversely, when interest rates are high and inflation is low or expected to remain low, the demand for gold as an inflation hedge may decrease.

3. Economic Conditions:

Changes in interest rates are often driven by central bank policies, which are in turn influenced by economic conditions. When interest rates are lowered to stimulate economic growth, it can lead to increased demand for gold as a safe haven asset. Conversely, when interest rates are raised to combat inflation or overheating in the economy, it can reduce the appeal of gold.

4. Currency Strength:

Gold is priced in U.S. dollars. Changes in interest rates can impact the strength of a currency, and a weaker currency can make gold more attractive to investors. For example, when the U.S. Federal Reserve raises interest rates, it can lead to a stronger U.S. dollar, which may put downward pressure on the price of gold in dollar terms.

Lauren Hua is a private client adviser at Fairmont Equities.

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