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If the Fed Hikes Rates in December, Where Could Gold Head Next?

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Gold versus Treasuries and equities

Gold prices fell sharply on November 2, 2015, as concerns grew over the potential interest rate increase by the Federal Reserve. As opposed to Treasuries and equities, gold is an asset that doesn’t give interest or dividends to investors. Holding physical or virtual gold investments does not provide any cash flows.

If the Federal Reserve raises interest rates, it could lead to a decrease in the price of gold. This was evidenced during the last few trading days as the FOMC (Federal Open Market Committee) pointed toward a rate hike in December.

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Effect of interest rate hike

A rate increase can have a dual effect on gold. Firstly, a rate increase could cause investors to put their money in Treasuries instead of investment gold. Secondly, an increase in rates may adversely affect equity securities, as companies may have to pay higher interest on their borrowed funds, possibly affecting their profitability.

A fall in equities could lift the precious metal prices higher as historically, stock market volatility has buoyed gold prices. The above chart shows the historical price performance of gold and the S&P 500 Index.

The Fed’s hawkish stance

As the language of the Fed meeting turned hawkish, gold prices seemed ready to fall. The announcement of a possible December rate hike also spooked hedge funds, which liquidated 345 tonnes of gold futures positions, sending gold prices tumbling.

Gold saw a five-day trailing loss of 2.60% as of Monday, November 2. Silver dropped almost 2.90% on a five-day trailing basis and closed at $15.40 an ounce. Platinum and palladium also fell, declining 0.82% and 2.80%, respectively.

Most of the ETFs tracking investments in gold and the gold mining industry have also dropped on a five-day trailing basis. During the past week, the Direxion Daily Gold Miners ETF (NUGT), a leveraged mining fund, fell 18.30%, and the Sprott Gold Miners ETF (SGDM) fell 5.30%.

Mining companies Gold Fields Ltd. (GFI), Yamana Gold Inc. (AUY), and Pan American Silver Corp. (PAAS), lost 5.80%, 8.30%, and 7.50%, respectively, during the past week. The fall was most likely due to the decline in precious metals and the growing uncertainty in the market. These three companies make up 9.50% of the VanEck Vectors Gold Miners ETF (GDX).

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