How Gold Prices Move When Interest Rates Rise

The U.S. Federal Reserve's two-day policy meeting ends today (Thursday). Everyone wants to know if the Fed will raise interest rates for the first time since 2008.

Fed Chairwoman Janet Yellen has been hinting for almost a year now that it's time to raise rates. Investors fear it would mean a major correction in stocks - and tanking gold prices.

The thinking is that higher interest rates make stocks and gold less attractive since they compete with bonds for investment dollars. Higher rates should mean new bond issues are suddenly more desirable.

Since gold pays no interest, a low or negative interest rate environment makes bonds more attractive. Or so the thinking goes.

gold pricesBut in reality, the opposite tends to happen.

Several decades of data show that when the Fed transitions from low or descending rates toward rising rates, gold actually gains.

In fact, gold tends to gain a whole year ahead of a rate increase. On average, gold prices rose an amazing 20% in the 12 months preceding higher rates.

Take a look at the following example - which also happens to be the most recent one...

When Interest Rates Rise, So Do Gold Prices

Over a two-year span, from June 2004 through June 2006, the Fed raised its benchmark fed funds rate a whopping 425 basis points, or 4.25%.

In the 12 months preceding that, the price of gold went from $345 to $405, for a 17.4% gain.

Starting in June 2004, through a total of 17 individual hikes, rates went from a low of 1% to a much more hawkish 5.25%. The Fed thought the economy was at risk of overheating and wanted to normalize rates.

Typically, average investors would have expected gold to be utterly smashed. Since gold pays no yield, demand for the precious metal should have fallen.

The result was the total opposite.

In that time frame, gold went from a low of $385 in June 2004 to a high of $640 in June of 2006. That represents a massive 66.2% gain.

Stocks, on the other hand, turned in a mediocre return.

The S&P 500 rose from 1,130 to 1,270, which represents 12.4% over two years.

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That's not bad. But gold clearly trounced stocks, which were outperformed by 53.8%, all while interest rates rose aggressively.

So you see, the exact opposite of what most people expect took place the last time the Fed began raising rates, and markedly so.

Gold moved up, defying expectations.

I don't think the next phase of rising rates, whenever it comes, is going to be any different.

In fact, it's a good idea to take advantage of what "the crowd" expects - and buy gold today.

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