The price of gold has skyrocketed in recent weeks, with the war in Ukraine as the main catalyst. Geopolitical instability has sparked fear among investors, who are ditching risky assets and moving closer to gold, driving its price close to an all-time high. However, there are other factors that could be even more decisive, such as the start of the interest rate hike cycle in the United States.
In the latest report published by the Australian Perth Mint, it’s head of research, Jordan Eliseo, underlines that this rise in the price of gold in recent weeks, coinciding with the invasion of Ukraine by Russia, has returned the precious metal to the level of $2,000 an ounce (A$2,800 an ounce).
This rise occurs after a correction period of about 15 months, in which gold has fallen about 15% between August 2020 and January 2022. Among the factors that have caused this correction, the Western Australian Mint analyst highlights the following:
- The rise in the price of the dollar by 6% during the year 2021.
- Greater-than-expected growth in the global economy.
- The extraordinary rise of capital markets, with the S&P 500 registering growth of more than 25% in 2021.
- The strengthening of the price of cryptocurrencies during the past year, with bitcoin approaching the barrier of 000 dollars a unit.
All these factors not specific to the precious metals market caused the price of gold to undergo a correction, after having risen approximately 70%, from less than $1,200 to about $2,050 an ounce between the end of 2018 and 2020.
Despite the fact that most analyzes attribute the recovery in the price of gold to the crisis between Russia and Ukraine, a new factor recently introduced into the equation may be decisive for the future of the precious metal: the rise in interest rates for part of the US Federal Reserve.
As Jordan Eliseo’s analysis points out, “in theory, the price of gold should fall in 2022, due to the coincidence of unfavorable factors such as the rise in interest rates and the conclusion of several of the quantitative easing programs that banks plants had put in place to support their economies during the pandemic.
In theory, gold offers no returns; Therefore, if the interest rates that one can receive for depositing their money in a bank account or in a time deposit rise, the so-called opportunity cost of owning gold would rise, which should be negative for the price of the metal.
But as Eliseo points out, in reality during the last 50 years it has been shown on many occasions that the price of gold tends to rise when interest rates rise. Apart from the situation in the mid-80s of the 20th century, when the price of gold fell by 10%, and from a slight decrease between 1993 and 1995, the price of gold has risen, sometimes considerably, in periods when the Federal Reserve has raised interest rates.
Thus, in the cycle of rate hikes that took place between January 1972 and July 1974, the price of gold went from $47.60 to $157.30 an ounce (+230.5%).
Between January 1977 and January 1981, gold went from being worth $131.30 to $506.50 an ounce (+285.8%).
Between May 2004 and September 2006, the price of gold went from $393.80 to $597.80 an ounce (+51.8%).
Finally, between December 2015 and July 2019, gold went from being worth $1,060.91 an ounce to $1,413.55 (+33.2%).
The average increase in the price of gold during the six cycles of interest rate hikes by the Fed between 1972 and 2019 is almost 100%.
“These data clearly underscore that higher interest rates by themselves are not necessarily detrimental to the price of gold . Movements in the capital market and the value of the US dollar, in addition to the conditions of the economy in general, influence the demand and, therefore, the price of the precious metal, “ says the Perth Mint report.
Another factor that will influence the evolution of the price of gold throughout 2022 is inflation. According to the report, gold does not always rise when the inflation rate is growing. However, its track record shows that it is one of the best assets in terms of protection against rising consumer price indices.
Data from the Perth Mint reveals that the price of gold in Australian dollars has grown by an average of 20% in nominal terms during years when inflation in Australia was equal to or greater than 3%.
What makes inflation expectations so relevant to gold price developments is that the market currently expects the inflation rate to fall rapidly and remain low for the next decade.
This expectation can be visualized with the following data: when the CPI rate reached 7% in the United States in December 2021, the ten-year core inflation rate, that is, what the market expects inflation to register in the next decade, barely reached 2.56%.
This difference is the largest in the last 20 years between the current CPI rate and ten-year core inflation. According to the Perth Mint analysis, the only time a similar difference has been recorded was in 2008, and then it was barely 3%.
At that time, as now, gold had gone through a period of correction during which it had fallen by approximately 20%. That period was short-lived and ended with an explosive rise of more than 150% in the following three years.
As the report points out, “given this trajectory and the fact that there is room for the CPI rise to slow even if it continues to exceed market expectations, there are many reasons to believe that the current inflation dynamics will cause the CPI to rise. gold price over the next few years, regardless of what happens to interest rates.