Lear Capital: Will Rising Interest Rates Skyrocket the Gold Price?

Zero Hedge's picture

Sponsored Post by Lear Capital

The great Gold Bull Market of the 20th Century is said to have started in 1972, just after Richard Nixon announced on August 15, 1971, he was taking the United States off the Gold Standard. At that time Nixon realized foreign countries were hoarding more gold and silver-backed currency than could actually be redeemed by the precious metal's reserves we held.

Once again, gold could be traded freely allowing the market to determine its fair value. At the outset, gold prices were fixed at $42.22 per ounce but by February 1972, moved to $48.26 as trading began. From there a steady rise would ensue to levels 17 times greater than this initial trading price. On January 21, 1980, the gold spot price reached $850 an ounce.

Removing us from the gold standard did not come without an anticipated backlash. As the dollar was no longer backed by tangible assets, its value in the world markets was sure to decline and it did. Hence runaway inflation. In pre-emptive fashion, the Federal Reserve began to raise interest rates to protect the dollar.

At the same time gold trading began to spool up, the prime interest rate was at its lowest level in 12 years at 4.5%. The Fed Funds rate was 5%. These levels marked the bottom for interest rates during the period when gold began trading in earnest in 1972. Levels that would not be seen again for decades.

From that point on, both interest rates and the gold price rose steadily. By the time the gold price peaked at $850 an ounce, the Prime Interest Rate was 15.25%, 3.4 times its level when gold trading began. And the Fed Funds Rate at 15% was 3 times greater in the same period of time.
With interest rates rising some 10 percentage points in 8 years, we learn the correlation between the rise in gold prices was a compounded 33% for every rise of just one point in interest rates. It must be noted, during the same period stocks rose a mere 1%.

If we now flash forward to find the next time interest rates reached an undisputed bottom, we find ourselves at a time just before Christmas 2008. On December 16, 2008 the Prime Rate moved from 4% to its current low of 3.25%. On the same day, the Fed moved its target Fed Funds Rate off of 1% to 0.00% - .25%. Where was the gold price at this key point in time? Precisely and ironically, gold was $850 an ounce.

Since December 16, 2008, both rates remain unchanged with no immediate signs of increase. Gold, on the other hand has risen from $850 an ounce to levels solidly above $1400 an ounce accounting for an annual compounded gain near 26%.

Looking back to 1972, we see rates and the gold price rose in lock-step with inflation. Today, we find ourselves in a lively debate over whether we are in an inflationary cycle or deflationary cycle. I will submit, as the markets express uncertainty over even this, the move higher in gold prices, since rates bottomed in December 2008, is more likely attributed to a safe-haven play than it is to inflation fears and rising interest rates.

Now a case can easily be made that the real gold bull market has not yet begun and will not until such time as rates begin a decided move higher. With interest rates locked in at these bottoms, there is only one way for them to go and that's up. And once that process begins, the real interest rate/inflation play can commence. So where is gold headed from here?

If history repeats, we can, once again, make the case that for each point rates rise we could see a 33% corresponding move higher in the gold price. If gold is $1400 an ounce at that time, just a 3% move higher in interest rates could see gold at $3290 an ounce based on current levels. A 4% rise would only be equal to a 12-month retracement of falling rates from December 2007 to December 2008. A repeat of such a retracement could put gold at $4375 an ounce or up 200% in just 12 months.

From there every added point to interest rates could become an explosion of its own as one single point higher in interest rates could see gold rise above $5,000 an ounce.

Is this possible?

In June of 2003, we find an example where the theory holds. As the country found itself digging out of the hole left by the Dot Coms of the 90s, interest rates had fallen to extreme lows. The Prime Rate was 4%, the Fed Funds Rate was just 1% and gold was $345 an ounce.

Again, in anticipation of inflation, the Fed began to raise rates. By June 2006, Prime was 8.25% and Fed Funds were 5.25%. Gold rose from $345 an ounce to a June 2006 high of $641.80. That translated to a 23% annualized return. As rates stopped rising and held for the next 15 months, the rise in gold price slowed to a more tempered but still pleasing, 12% annual rate. A clear indication that this move could be attributed more to rising rates and inflation fears than any other impetus.

Any way you look at it gold now has several ways to win. Rising debt, falling dollar, default, war, weak housing, stumbling markets and yes . . . rising interest rates.

Since April 2001, when gold prices hit a 22 year low of $255.95 an ounce, the gold price has risen some 400% as the gold market reacted to a myriad of various stimuli at different times. We have seen gold behave as a commodity, as for a time the gold price rose along with oil. We have seen gold prices rise in response to geopolitical unrest, 911 being case in point. And as markets have floundered we have seen the pure safe-haven play as the economy and markets became engulfed in uncertainty over rising debt a falling dollar and fear of default.

What we have yet to see is a sustained battle against inflation. A battle fought by raising interest rates. An imminent battle as the entire world works to re-inflate a global economy. When this occurs, the combined effect of rising rates, with any of the stimuli already shown to drive gold prices higher, could be explosive.

Watch for signs that the second great gold bull market in history is about to begin. For breaking news on the economy, the markets and the trend in gold, visit LearCapital.com to request a FREE Gold Advantage Investor Kit and Special Economic Reports.

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Harlequin001's picture

This idea that gold prices are linked to interest rates is complete and utter bollocks. The gold price was rising in 1971 because the US had already been printing too many dollars, even under a gold standard. Most CB 's at the time were sending their export dollars back to the Fed almost immediately apart from the French, who had been stockpiling for some time.

When De Gaulle attempted to exchange his stockpile of dollars for gold Nixon shut the window. At that time the world was effectively saying' show us your gold backing' which had Nixon got he would have shown because as we all know, no politician can resist a political edge if its free, and doing so would most certainly have calmed the worlds fears about inadequate gold backing of dollars.

We can only deduce from this that the US didn't have sufficient gold to back its dollars, and that's as far back as 1971...

It matters not that interest rates rose upto 1980, the only reason the gold price collapsed subsequently was because of the introduction of the Washington Agreement which effectively released every CB from the need to convert foreign currency (read export dollars) to gold. Now they convert export dollars to a US T Bill or Euro bond etc so there is no demand for gold or sale of dollars. It was this collapse in demand from CB's which led to a collapse in gold prices as they became net sellers instead of buyers.

It was entirely a short term manipulation which is now over.

The Asian currency pegs created an artificial strong dollar economy in which wages didn't increase as they should which in turn resulted in credit based asset bubbles as the US Govt tried to make Americans wealthy through asset appreciation instead of net earnings. The only consequence was that Americans eventually 'spent up' using too much of a static take home pay to service mortgages and credit card debt. At that point the dollar began to fall because Greenspan/Bernanke knew that the only way they could replay the same game was for Americans to earn more money and take on more debt. That means lower dollars and higher inflation in a world geared up for inflexible exchange rates and exports to an economy gone bang. Lowering interest rates has got nothing to do with rising gold. If it did we would all have some and clearly we don't.

The gold price is rising because more people are concerned about the value of their money. We will soon see an environment where interest rates are rising in conjunction with the rising gold price.

The fact is that gold prices dictate interest rates, not the converse, because when gold is in money I don't need to invest or save it in banks. I can choose to do nothing, which means that the banks have to tempt me with yield to get me to give it up. I am everyone, I am Joe Public the world over.

Interest rates are entirely false. The introduction of the Washington Agreement should be recorded in history as the greatest manipulation of financial and commodity markets ever by anyone and anything. That manipulation must now be taken out, which means higher rates, higher gold, lower housing, less credit and higher food.

An absolute disaster by any means that was  entirely avoidable, thanks Greenspan & Bernanke et al for nothing. We would have been and will be better off without you.

'Watch for signs that the second great gold bull market in history is about to begin.'

Hmmm.. Well done Lear Capital, you're about 10 years late with that one...

Cvillian's picture

Damn straight homeboy.

Normally I respect people who get posted on this site but Lear's analysis is so effing weak and that's coming from someone who is uber-long PMs.

Stuck on Zero's picture

Harl: Your statement: "This idea that gold prices are linked to interest rates is complete and utter bollocks." may lose some relevance this time around.  The only way that the bankrupt Western governments can pay higher interest on their huge debt load is by printing more money.  That drives the price of old bonds downward scaring the begeezuz out of potential investors thinking of buying new bonds. Everyone who owns a 2% treasury note is angered by the new investors who get 4% and is unlikely to ever buy government debt again.  Why jump in at 4% when it may go to 6%?  Scared about reinvesting in new bonds investors may move to something more tangible: like PMs. 

Harlequin001's picture

Zero, I think you're quite correct. Normally I wouldn't make the statement because under a gold standard interest rates are set by the markets i.e I keep my gold in money unless a better more worthwhile opportunity arises, but these rates are set by CB's which makes them entirely false and not indicative of market forces or the direction of any pricing in anything other than credit.

There's no way I'd lend my money to a bank in any form (including deposits) at these rates of interest ergo I buy gold.


reader2010's picture

Look at the real rate instead, bitchez.

Philidor's picture

It's true that higher interest rates tend to be associated with higher gold prices, but I wouldn't interpret this relationship as one of causation, as the author seems to; rather, it's that a common factor, inflation (money-printing) is driving both interest rates (as people seek real return) and the gold price (which adjusts upwards as more money chases a relatively fixed supply).

Nigh Eve's picture

I agree.

A strong enough hike in interest rates would strengthen the US Dollar and, thus, mitigate the rise in gold prices - perhaps even causing them to fall.

The author cites the time period between 2003 and 2006 as evidence.   However, what really happened in that time period was that the Fed failed to be aggressive enough to fight inflationary forces.

Those other inflationary forces included the following:

- The Shadow Banking system running wild with CDO's and CDO's-squared, cubed, etc.  (which, in turn, helped to fuel the "easy-credit" for the housing boom.) 

- The wealth effect of the Republican tax cuts.

- 2 wars

- The extra-large budget deficit.


I am surprised that Zero Hedge would allow such a flawed argument to even be published as an article.

Vint Slugs's picture

Hey, it's a sponsored post.  The rent has to be paid.

caveat reader.  Not everything you're going to find here features flawless logic let alone a rock solid premise.

Thomas's picture

It's called a lurking variable.

Greenhead's picture

On the average, since 1973, the dollar cost of gold has increase at about a 10% rate.  So much for the CPI.  Of course, one could argue that gold was undervalued artificially in 1973 but the dollar, as measured against that standard, has been greatly reduced in value mostly because of the increase in the Frn's.

No wonder the middle class is angry.  Most wages haven't increased at 10% a year over the last 38 years.

NidStyles's picture

I would have been interested in seeing how this played in with the open manipulation and the ETF's as well. Especially with silver. Yes, I know I could go figure it out on my own, but I have enough on my plate. I'm also quite lazy after work.

disabledvet's picture

"Credit Default Swap."  My question is "is that what causes instant interest rate shocku"?

fasTTcar's picture

I have been actively buying gold and silver for a decade and the flashing exit sign for me will be 75+ basis point rate increases.

SuperRay's picture

so if this is a sponsored post, what are they selling?  There's no way out of this mess.  the scumsatan will keep pumping paper until everything collapses.  If he raises rates, everything collapses. even my non-financially educated brain can pick out the theme here. All we can do now is thank Blythe and co for keeping the PM prices low enough so we can stock up for the postappocalyptic barter trade, cause if you don't have something anyone wants, you're not going to get anything you need

iinthesky's picture

So where's silver play into all this?

Sathington Willougby's picture

Cheapen your money over time and what do you get, in the long term cheap money. 

In a quest to exchange their pittance for real money, hapless slave-citizens turn to USD.XAU.

When USA goes to A- rating (rock bottom default imminent), rates have to go up, but so what the damage is done.  There's no economy left to back anything. 

Plants shut down, motor city locked up since someone punched a hole in the oil pan (unions).  No influx of real energy (crude) coming from our own soil (just green wet dreams encouraged to create fake transactions).  Now Toyota isn't pushing parts or cars, jobs are vanishing faster than ever.

I'd like to see you stop this one way bullet train to nowhere.

"you better just have yourself a damn good conductor" - Leonard Nemoy.

Paging Dr. Paul, you're needed in the ICU...bleep bleep bleep beeeeeeeeeeeeooop....

Clapham Junction's picture

God, another of these.

The answers: "No" and "No."

You make it sound like rates move magically higher.  The FED follows the 3mo T-bill.  Watch that for your clue when rates will be raised.  Again, the FED follows the T-bill market, not vice-versa.

You'd think a pro would know that.