Why an increase in real interest rates makes gold lose its sheen


Nov. 20 2020, Updated 4:28 p.m. ET

Increase in real interest rates impact gold

Gold doesn’t give any returns besides appreciation. Appreciation doesn’t always happen. As a result, gold has to compete against assets that yield something. When the return on the alternate assets begins to rise, the demand for gold falls. In a scenario where the real interest rates—nominal interest rates adjusted for inflation—are rising continuously, the demand for gold, as an investment, will start falling.

 Gold price vs real interest rate

The above chart shows the relationship between real interest rates and gold prices. U.S. real interest rate is the three-month Treasury bill (or T-bill) rate minus the U.S. Consumer Price Index (or CPI) change. The price of gold was adjusted for inflation in July 2014.

The above chart shows that when the real interest rates were negative—during the 1970s and in the last few years—gold prices were rising. The fall in gold prices from their peak in 1980 until 2001 is associated with positive or even rising in the real interest rate environment.

Real rate environments aren’t all equal

However, these periods when inflation changed were quite different from one another. We’ll compare the periods based on the following factors:

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  • Inflation – The 1970s had negative real interest rates when inflation was very high. The low real interest rates during the 2000s were mainly associated with the low nominal and low inflation environment.
  • U.S. dollar – During the 1970s the U.S. dollar was enjoying mixed fortunes. However, there’s usually a slight decline. During the last few years, the U.S. dollar has been declining on average.
  • Gold demand and supply – The period from the 1980s to the 1990s was characterized by an active central bank and producer-hedging activity. Now, central banks are net buyers. Producer hedging is at minor levels.

Real interest rates are important to understand gold prices. However, you have to know when real interest rates are important. Gold’s relationship with U.S. real interest rates changes. When emerging markets and their currencies become stronger, their macroeconomic factors will become more important to determining gold prices. It’s important to track the changes in real interest rates in the U.S. and worldwide. Gold prices impact gold stocks like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), Agnico-Eagle Mines (or AEM), Yamana Gold (or AUY), and exchange-traded funds (or ETFs) like the SPDR Gold Trust (GLD) and the Gold Miners Index (GDX).

Visit the Market Realist Gold ETFs page to learn more about investing in gold.


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