The role of gold in portfolios as rates increase

There has been no better time to buy Gold than now and that’s due to several reasons. Firstly, gold is trading at a discount to its all-time high of $2,788.77/oz, hit in March 2022 on the back of war in Ukraine and rising global inflation. At today’s prices Gold is trading at $2,574.15/oz which is at a 10% discount to its all time high.

At that time, there were also concerns about the supply of physical gold due to air travel restrictions caused by lingering pandemic, and the closure of precious metal refineries and gold mines. Following the Ukraine war, equities markets suffered large falls as the crisis unfolded and central banks around the world started raising interest rates to combat rising inflation.

With the large falls seen across global share markets, gold had a tiny correction due to hedge funds and speculators unwinding long positions. The 15 percent pullback in gold and other precious metals was a healthy one, especially for those looking to secure a position in the safe haven asset.

Several factors drove this correction, including:

• A rising US dollar, which was up 6% in 2021.
• Stronger than expected economic growth.
• An incredibly strong rally in equities, with the S&P 500 up more than 25% in 2021.
• Cryptocurrency price strength for most of 2021, with Bitcoin at one point pushing up toward USD 70,000 per coin.

Gold was overdue for a correction having rallied by 70 percent since late 2018 and late 2020.

During times of turmoil, investors have always turned to gold given its safe haven status and hedge against inflation. The global discussion around rising inflation and central banks hiking interest rates is often associated with challenges in the price of gold.

Digital money platform, Rush Gold, says “Historically a rise in rates has been viewed as a negative for the gold price (a view that we challenge based on the actual data). According to this view, as bonds pay higher and higher interest, gold has a more difficult time being competitive because true gold ownership comes with holding costs. But this argument also contains an embedded logic bomb: the conditions that would cause the flow of money from gold to bonds also represent a threat to the very value of those bonds.”

As central banks starting moving interest rates higher, investors moved out of low interest bonds and into higher ones, reducing the value of the low interest ones. “But given the fact that the bond portion may not perform as well as it recently has, there is a strong argument that a gold allocation can be increased even further at this stage in order to protect portfolio capital,” says Rush Gold.

Given the outlook for interest rates is up (markets expect rates to rise to 1.5% by year-end and to 2% by mid next year), higher rates is usually a negative for gold. Isn’t it? 

In theory, yes. Investors move out of non-interest-bearing assets, and into higher interest paying assets as rates rise. Gold doesn’t pay an income. Therefore, the opportunity cost of owning gold is higher, and should be bearish for the gold price. But, gold prices have typically moved higher as interest rates moved higher. And this was especially true during times of turmoil.

The other thing to take into consideration, is the fact that economists expect inflation to drop rapidly and stay low in the decade ahead. The reason for this, was because of the massive stimulus that was injected into the economy due to the pandemic.

Given this backdrop, and the very likely event that inflation will fall in the years ahead, gold prices look attractive at these levels, irrespective of what happens with interest rates.

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.