How does gold react to interest rates?
There is a popular understanding that there exists a negative correlation between gold prices and interest rates. However, historic data and shows that this is not necessarily true. In fact, gold usually performs well when interest rates are negative, however there is no hard and fast rule about this pattern of behaviour.
Apart from interest rates, there are some other factors people believe that gold rates are associated with. Let us look at each of them.
Dollar vs. Gold
The past two decades of data show several correlations between the gold price and the US Dollar.
At the beginning of the 2000's, there is a clear up and down in the Dollar price, but very little change in the gold rate accordingly. However, right after the 2009 recession, there is a fall in the price of gold against the rise in the value of the US Dollar. Recently, the correlation between the US Dollar and gold has been random. Overall, the data doesn't show that there is a negative correlation between the gold price and the Dollar rate. Rather, it shows that there is no specific correlation. However, it is true that gold historically has been inversely correlated with the US Dollar.
The truth is that neither interest rate policies nor the US Dollar can really explain the fluctuations in the gold price.
Some investors believe that gold's increase in value to nearly $2000 is due to the weakening of the Dollar. However, these claims can only be substantiated using small sub-segments of data. Be aware that the gold rate has fluctuated between $380 to $1880 Dollars. To conclude, we can positively say that gold has an unremarkable correlation to the US Dollar.
Faith in Central Banks vs. Gold
Faith in central banks, however, does impact the price of gold. When US inflation hit a record high in 1980 at 14.8%, the Fed responded by raising rates to 20% in 1981. Gold prices plunged after that but that had little to do with the rates themselves. Instead, rates hikes restored public faith in the central banks, which in turn allowed people to believe that the Fed had control of the economy.
In 2012, Mario Draghi of the ECB stated that he would do “Whatever It Takes” to preserve the ration ratio. In reality the ECB didn’t do much. However, Draghi's words were enough to restore faith in the central bank, which affected the gold.
What moves the Gold Market?
As Erb and Harvey noted in their paper 'The Golden Dilemma', the gold has a positive elasticity. This means that as more people buy gold, the price of yellow metal rises accordingly with demand. It also means that there is no basis fundamental to the gold price and it is not affected by monetary policy.
Rising interest rates may affect currencies, which subsequently may affect the prices of gold. However, the price of gold is actually correlated with market demand, supply and investor behavior.