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6. Gold as an inflation hedge probably won’t work.

Portfolio > Alternative Investments > Commodities

Why Gold’s History as Rates Rise Suggests More Room to Run

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What You Need to Know

  • The historical performance of gold when interest rates rise contradicts the conventional wisdom.
  • Gold prices increased when the Fed raised rates in the mid-1990s, June 2004-July 2006 and December 2015-December 2018.
  • State Street's bullish case for gold to trade between $2,000 and $2,200 is becoming more likely.

For the longest time, there has been a common misperception that the price of gold will fall during periods of monetary tightening. While this may be true as a “knee-jerk” reaction, history suggests that once the reality of a rate increase sets in, gold prices can continue to rise. In fact, an argument can be made that raising interest rates can actually improve the outlook for gold prices. 

Typically, in periods of sustained high inflation, the Federal Reserve will raise interest rates in an attempt to reduce the excess demand in the economy. That is exactly what’s happening now. Fed Chair Jerome Powell made it clear he is worried that inflation could become a long-term problem, and the Fed recently decided to raise rates for the first time since 2018.

Conventional wisdom would dictate that gold should fall since the Fed is essentially increasing the opportunity cost of holding gold at this time compared with higher-yielding assets. Not so fast! When you look at the historical performance of gold in rising rate environments, quite the opposite is true.

Dating back to 1954, there have been at least three distinct periods of time featuring multi-year increases in the federal funds rate. Let’s first look at the most recent period of monetary tightening, between December 2015 and December 2018, a three-year period that saw the Fed raise rates nine times and the price of gold rise 21%.

Further, the Fed was in tightening mode between June 2004 and July 2006, raising rates 17 times in the two-year period, and the price of gold posted another impressive rise of 21%.

Finally, a three-year period in the mid-1990s, when then-Fed Chair Alan Greenspan seemed to be raising rates at just about every meeting, saw gold rise 24%. At the time, I was a trader at Shearson — later Lehman Brothers — and asked one of my hedge fund manager clients why he was steadily buying gold when Greenspan was consistently raising the opportunity cost of holding the asset.

The client responded that if the dollar needed as much protection as the Fed was providing, it must be in even worse shape than was apparent on the surface, and it all began to make sense to me. 

What he was doing was buying protection against further weakness in the dollar. So even in a rising rate environment where there may be an opportunity cost to holding gold versus certain assets, the precious metal is still serving its purpose as a safe investment — in that instance, a haven versus the dollar. 

In this context, it is also interesting to note that Fed Chair Powell has recently moved to persuade the markets to dial back their expectations of what the Fed might do in response to persistently high inflation. Market commentators initially suggested the Fed might feel forced to raise rates between its regular meetings, yet Powell has made it clear that he doesn’t expect anything of the kind. 

There has also been market chatter that we could see six or seven rate increases this year, as opposed to the previous consensus of three or four hikes. It remains to be seen whether that will prove feasible given Powell’s dual mandate of presiding over monetary stability and ensuring full employment. 

As Powell has pointed out numerous times, while the employment situation in the country is improving, he remains acutely conscious that there are some 4 million fewer people in the workforce today than there were before the onset of COVID. 

In light of all this, State Street’s Gold Strategy Team put together three separate potential gold price ranges through 2022 at the start of the year. Our base case called for gold to range between $1,800 and $2,000, with a 50% probability of this happening. Our bullish case suggested a range between $2,000 and $2,200, with a 30% probability of occurring, and our bearish case indicated a range between $1,600 and $1,800, with just a 20% probability.

Our outlook for these scenarios was based on there being no dramatic changes in the economic and political environment at the time, but clearly, we have witnessed substantial events since then. U.S. inflation has continued to rise, recently hitting a 40-year high, and Russia’s invasion of Ukraine has brought a significant increase in political tensions around the world.

With these developments paired together, the allure of gold as an investment has never been stronger, and my bullish case for gold to trade between $2,000 and $2,200 is becoming a more substantial possibility — proving once again that gold always responds well to uncertainty.


George Milling-Stanley is chief gold strategist at State Street Global Advisors.