EC HH Gold And The Federal Funds Rate

Wrong Assumptions

It is widely assumed that the gold price must decline when the Federal Reserve is hiking interest rates. An example is given by this recent article on Bloomberg, which informs us that SocGen believes “gold will be a casualty of Federal Reserve policy”. Never mind that the assumption that the Fed will now be able to simply embark on a “normal” rate hike cycle is in our opinion utterly absurd. It will only do that if the inflation genie unexpectedly gets out of the bottle, and is guaranteed to remain “behind the curve” if that happens (more on this further below).

Image via 

gainesvillecoins.com

It seems logical enough: gold has no yield, so if competing investment assets such as bonds or savings deposits do offer a yield, gold will presumably be exchanged for those. There is only a slight problem with this idea. The simple assumption “Fed rate hikes equal a falling gold price” is not supported by even a shred of empirical evidence. On the contrary, all that is revealed by the empirical record in this context is that there seems to beabsolutely no discernible correlation between gold and FF rate. If anything, gold and the FF rate exhibit a positive correlation rather more frequently than a negative one!

Let us look at exhibit one – the 1970s:

So the gold price is falling when the Fed hikes rates? Not in the 10 years depicted above, when it did the exact opposite. It rose by 2,350% over the decade, and the vast bulk of the increase happened while the FF rate rose sharply. Gold did however plunge by almost 50% in a mid cycle correction from late 1974 to mid 1976 – while the FF rate actually went down

So the guessers at SocGen might actually have improved their statistical odds a bit if they had said “now that the Fed is hiking rates, gold prices should rise”. The reality is though that even if they knew perfectly well what the Fed was going to do next year – which they don’t, as not even the Fed itself knows – they could not possibly make a correct gold price forecast based on that information.

Let us look at a few more historical data – here is the gold price and the FF rate from 2001 to 2015. The best interpretation one can come up with on the basis of the raw data is that there simply exists no fixed correlation:

Gold and the FF rate since 2001: What the gold price ends up doing seems to have very little to do with the federal funds rate

It Simply Isn’t That Simple

Now, if you have taken the time to read the article at Bloomberg we linked to above in its entirety, you will have noticed that it actually offers no analysis whatsoever. The SocGen analyst quoted by Bloomberg is simply parroting the current consensus.

In August of 2011, the same guy would probably have told us why gold was certain to go higher over the next year (this is beside the fact that Wall Street loves to hate gold – after all, a rising gold price most of the time coincides with bad business for WS).