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What If the FOMC Raises Interest Rates in 2015?

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Oct. 27 2015, Published 7:31 a.m. ET

A “what if” scenario

Gold prices gained some ground yesterday due to a possible delay in the rise of interest rates. The overall world economy seems cold, and monetary easing in China and Europe likely stands as a barrier to a rate liftoff. As the Federal Committee is set for a meeting today and tomorrow, gold enthusiasts have their eyes set on the outcome. Initially, the chance for a liftoff seemed better, but the market is now betting against a rate increase this month, with just a 6% probability of rates being lifted. Wall Street is pricing a 36% likelihood of a rate increase in December. Although the FOMC members seem optimistic about a rate hike in the current year, market participants assume the hike is postponed until next year. However, let’s analyze a “what-if” scenario where we consider the possibility of a hike in the current year.

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Bullions may slide

The above chart helps to explain the historical relationship of gold to real interest rates. As mentioned, if the FOMC decides to raise rates in the current year, gold may lose its shine and retreat. As seen from the September meeting, the delay in the rate hike gave a lift to bullion prices. If the FOMC decides to raise the rates above the current zero mark, money will flow to the Treasuries, dimming the appeal of the precious metals. As we all know, the price changes in gold are most affected by the Fed decision, and the monetary policy of the country in turn affects the FOMC decision.

Investors should clearly expect to see a plunge in bullion prices at least initially when rates are lifted. The fall in the bullion will also be seen in bullion-backed ETFs such as the Global X Silver Miners ETF (SIL) and the SPDR Gold Shares ETF (GLD). Also, major mining equities such as Eldorado Gold Corp. (EGO), Kinross Gold Corporation (KGC), and Hecla Mining Company (HL) may fall as the bullion drops. The three companies make up 8.5% of the VanEck Vectors Gold Miners ETF (GDX). A fall in the stocks that make up GDX ETF can also result in lower prices for GDX itself.

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