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.
