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How Could a Negative Interest Rate Scenario Impact Gold Prices?

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Interest rate hikes

The expectations of interest rate hikes by the Federal Reserve was one of the largest factors weighing on gold prices in 2015. An increase in interest rates diminishes the appeal of gold, which doesn’t pay any dividends or interest. So, a lower-than-expected interest rate frequency or amount would be positive for gold prices.

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Expectation of rate hikes

The Federal Reserve chair, Janet Yellen, noted on February 10 that the risks to economic outlook could delay the central bank’s plans for raising short-term interest rates. Yellen added, “Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar.”

With this, the expectations of an interest rate hike in the Fed’s next policy meeting in March have diminished considerably. Plus, the deterioration in the high yield (HYG) and equities markets is not giving positive signals for any tightening in the near term.

Federal funds futures, which are used to hedge interest rate risk, are also factoring in a maximum of one interest rate hike until the end of 2016. These futures are for a particular month and are priced as 100 minus the expected federal funds rate. By looking at a series of future months’ rates, investors can get a clue about the likely expected direction of the federal funds rate.

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Preparing for NIRP

The Federal Reserve has asked the banks to prepare for the possibility of a negative interest rates policy (or NIRP). Right now, it is being done as a stress testing scenario to see how the banking system could be affected by it. This means people are charged on their deposits with banks, and banks are charged for their deposits with the central bank. This dissuades idle cash balances and artificially boosts demand.

Japan has recently implemented negative interest rates. Whether the country is able to achieve the desired results still remains to be seen. However, a NIRP scenario is usually seen as a last resort to kick-start growth in an economy.

While any such move by the Fed is still far-fetched, gold should be the first one to run up in such a scenario. Negative interest rates mean that even the bonds could bring negative yields. This could be beneficial for gold prices (GLD) (IAU) as well as gold stocks such as Pan American Silver (PAAS), AngloGold Ashanti (AU), and Franco-Nevada (FNV).

Mining-based leveraged ETFs like the ProShares Ultra Silver ETF (AGQ) and the Direxion Daily Gold Miners ETF (NUGT) could also run up if such a move is implemented.

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