Precious metals May Get Allergic from a Fed Rate Hike
No cash flows for precious metals
There are several price determinants for precious metals, including inflation, economic stability, the US dollar, equity markets, and many more. Among these determinants, interest rates remain crucial in deciding price changes in precious metals. Gold is likely to be the most affected by changes in the real interest rates. Other metals like silver, platinum, and palladium take their change directions from gold and are also closely linked to the interest rates.
Treasuries and equities have an almost inverse relation to the commodities markets. Commodities and particularly precious metals are known as an alternative investment to investors. These metals, however, offer no cash flows from interest from Treasuries and dividends from equities. Investors lean towards these cash flow-bearing securities when they offer higher intermediary flows. The chart above shows how gold has historically reacted to changes in the interest rates.
Expansion versus tightening
Interest rates in a country decide whether the economy is expanding or tightening. Lower interest rates suggest that the government is easing and letting more money through the economy, thus expanding. Higher rates, however, curb the flow of money into the system and lead to a tightening phase.
Another important link between interest rates and the economy is that higher rates cause money to flow into the country from global investors, pushing up the demand for the home currency and giving it a boost. Lower rates, on the other hand, cause money to flow out of the country and a lead to a sell-off of the home currency and pressurize it.
As precious metals are related to interest rates, themselves linked to economic expansion and tightening, gold is apparently affected by the stance of an economy. This is especially the case in major markets like the United States, Europe, and Japan.
The changes in precious metal prices affect the companies that are into the mining business like RandGold Resources (GOLD), Yamana Gold (AUY), Pan American Silver (PAAS), Coeur Mining (CDE). These four companies make up 11.2% of the Market Vectors Gold Miners ETF (GDX).
In this series, we’ll study the impact of changes in the US interest rates on precious metals.
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