Take everything you think you know about gold and toss it out the window, because there’s a very real possibility that physical gold can continue to rise even as the Federal Reserve moves forward with its monetary tightening.
Forget what you think you know about gold
Generally speaking, higher interest rates are the enemy of physical gold, and it all ties into opportunity cost.
Gold itself offers no dividend yield, so it relies on a number of external factors, which we’re going to get to a bit later, to drive investor demand. One of those factors is interest rates and yields on interest-bearing assets. If yields on bonds, bank CDs, and savings accounts, are relatively low, then some investors may be willing to give up a small, but safe, nominal gain in favor of buying gold, which could offer a bigger return. Conversely, if yields rise on these safer assets, it makes less sense from the standpoint of investors to give up these guaranteed gains and buy gold, thus hurting demand for the physical metal and sending its spot price lower.
On paper, the current tightening the Fed is conducting should be bad news for gold. Since Dec. 2015, the Fed has increased its federal funds target rate by 75 basis-points to a range of 0.75% to 1%. Though that’s still historically very low, the Fed has a long-term fed funds target rate of 3% that it’s aiming for. This very well could put U.S. Treasuries and bank CDs back in the 3% to 4% range, making them quite attractive to risk-averse investors.
Yes, gold can rise in value as the Fed raises rates
But, as I’ve learned over my nearly 20-year investing career, things don’t always happen as they should on paper. Gold and gold stocks could very well wind up pushing higher even as interest rates rise another 50, 100, or even 200 basis points in the next two to three years. Here are three reasons you’d be smart to consider gold and gold stocks for your portfolio despite what the textbooks may tell you.
1. Inflation acts as a natural check
Arguably the biggest reason to consider being a bull on gold despite rising rates is the push-pull mechanism known as inflation. Inflation measures the rising price of a predetermined basket of goods and services.
Typically, the higher inflation goes (i.e., the quicker prices are rising), the more attractive gold becomes. The reason is simple: inflation is usually correlative to economic expansion. When the economy is growing, the Fed is often expanding the money supply, which dilutes the value of existing dollars in the marketplace and makes it more expensive to buy assets that have a perceived store of value, such as gold. Yet, the Fed also raises its fed funds target rate when the economy starts to heat up. Thus, higher inflation rates can help counteract the adverse impact of higher interest rates in a growing economy.
According to the Bureau of Labor Statistics’ February inflation data, the Consumer Price Index for All Urban Consumers (CPI-U) grew by 2.7%, implying that inflation is heating up for the first time in more than three years. That’s good news for gold.