US interest rate rise may not be bad news for gold prices – WGC

Otmane El Rhazi from The Bullion Desk.

Higher US interest rates may not be as negative for gold as many believe, the World Gold Council has claimed.

The relationship between gold and interest rates is more complex than it seems and weaker than it was previously, it said in a report on Thursday.

“Other factors influence gold – including some positively correlated to economic growth – highlighting its role as a key diversification and risk-management portfolio asset. This is an increasingly important role, as both stocks and bonds may deliver lower-than-average returns in coming years,” it added.

Speculation over when the US may choose to raise interest rates from near zero, where they have been since 2008, has been heated over the past 12 months.

While the Federal Reserve was initially expected to lift rates for the first time in a decade in June, a run of mixed data, low inflation and dovish comments from chair Janet Yellen on the country’s rate of growth has pushed back the timetable.

When rates do rise, the general consensus is that gold will come under heavy downside pressure on gold – the opportunity cost of holding the metal will rise, pushing investors to yield-bearing assets.

“However, jewellery and technology demand make up almost 60 percent of annual physical gold demand,” The WGC says. “For these markets, there is an indirect positive relationship to interest rates – higher interest rate cycles typically coincide with higher economic growth and consumer spending.”

Europe and North America account for only 17 percent of total gold demand, according to the WGC, of which only 60 percent is linked to investment.

As well, the US interest rate argument is not as strong as it once was – the case was built largely on an analysis of gold and interest rate performance during the 1970s and 1980s, when economic conditions were very different from today, the WGC said.

“The gold market is different too,” it said. “Developed-market gold demand has declined to less than 30 percent over the past decade from more than 60 percent in the 1970s. Emerging-market demand, which accounts for 70 percent per year, is less sensitive to US rate changes, and to a great extent jewellery and technology demand is pro-cyclical.”

On the investment side, the metal’s credentials as a portfolio diversifier will also endure.

“Gold has been reliably effective at diversifying investment portfolios and reducing risk at real interest rates even when interest rates are positive, up to 4 percent,” the WGC said.

Current short-term US real rates are still very low and far from that threshold. As of December 31, the three-month and 1-year US Treasury-bills were yielding -0.73 percent and -0.6 percent respectively in real terms, the council said

“Higher interest rates will not improve fixed-income’s prospects. At current yield levels, bonds are likely to have limited upside and… would therefore be less effective than gold in mitigating equity risk,” it said. “This will help gold demand because some investors will use gold to complement bonds in managing equity risk and diversifying their portfolios.”

(Editing by Mark Shaw)

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