This is a guest post.

The author, Gavan Smythe is the founder of iCompareFX. 

This online platform gives people an easy way to compare the world’s best international money transfer companies across different services and features. Outside of work, Gav enjoys spending time with his loved ones.

Gold investors often have to brace themselves for varying degrees of volatility, depending on factors such as interest rates, the strength of the dollar, and intervention by the central bank. From a high of over $2,000 per ounce in August 2011, its value fell to around $1,200 per ounce toward the end of 2015, and then again in September 2018. With the federal government cutting interest rates by 0.25% in July 2019, for the first time in the last decade, gold investors might have reason to cheer.

Central Banks and the Lure of Gold

Central Banks of different countries have bought considerable gold in recent times. Poland, for instance, has purchased 378 tons of gold from January 2019 to July 2019. In June alone, central banks added more than 125 tons of gold in their coffers. Other big buyers on the list include Russia, China, Kazakhstan, Turkey, and Kyrgyz Republic.

Is There a Correlation Between Real Interest Rates and Gold Prices?

Many financial experts opine that high real interest rates tend to have an adverse effect on the price of gold, and they believe the converse as well. A paper published by the National Bureau of Economic research shows a correlation of -0.82 between real interest rates and the price of gold. The logic behind this is that a high interest rate environment makes non-interest bearing assets such as gold less attractive to investors because of higher holding or carrying costs.

Data suggests that gold prices have risen noticeably during periods that have experienced negative real interest rates. When the inflation rate exceeds the real interest rate, creditors end up losing money. As a result, it makes them prone to invest in gold, despite the fact that they’ll earn neither interest nor dividends.

In a negative interest rate environment, gold commonly reclaims its role of a traditional store of wealth. This is because its value usually keeps pace with inflation, giving investors the ability to maintain or build on the purchasing power of their capital. Bonds, on the other hand, experience real losses when real exchange rates take a dive.

Historically Speaking

Examples that highlight the correlation between real interest rates and the price of gold are not hard to find. The value of gold increased sharply from mid-1976 to the beginning of 1980. This was a period when real interest rates and inflation rates were high. Since the returns on bonds did not keep pace with the rising inflation, investors chose to turn to gold. In the then prevailing negative interest rate environment, the price of gold increased, getting it to its all-time high value of over $2,100 per ounce. The boom ended when short-term nominal interest rates were increased by Paul Volcker, causing real interest rates to enter positive territory again.

Another instance of gold prices increasing at the same time when there was a drop in real interest rates was when the federal government announced a rate cut in late 2007. Interest rate hikes implemented by the government tend to have a deflationary effect, which can cause gold prices to drop, even if it’s only temporary. On the other hand, if there is no sign of a hike in the future, the price of gold can rally because of anticipated inflation.

If you have allocated around 10% of investible assets toward physical gold, you can consider yourself in a good position. If you haven’t, this seems to be as good a time as any to get on the bandwagon, and then just sit back and watch the future unfold.

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About the Author

Gavan Smythe is the founder of iCompareFX. This online platform gives people an easy way to compare the world’s best international money transfer companies across different services and features. Outside of work, Gav enjoys spending time with his loved ones.

 

Disclaimer 

The opinions expressed by the guest writer does not necessarily reflect the opinions of MyFinancialShape. MyFinancialShape is not responsible for the accuracy of any of the information supplied by the guest writer.

This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.