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Can gold withstand rising US rates?

Gold investors also need to consider how quickly the Federal Reserve reduces its balance sheet
Can gold withstand rising US rates?

Ben Bernanke, the former chair of the US Federal Reserve, once famously remarked that “no one really understands gold prices”. He may have a point. The market dynamics currently in play are certainly challenging for the ordinary investor. But they can be unravelled by examining the relationship between the price of gold and other assets, specifically US government bonds.

The price of gold has risen 10 per cent since the start of the year. And yet US interest rates are rising as the Federal Reserve tightens monetary policy by raising the overnight federal funds rate. Meanwhile, the stock market has recently hit record highs. In classical thinking both of these factors ought to be keeping gold prices in check.

First, let’s look at rates. All things being equal, gold should fall in value when interest rates rise. The calculation appears simple enough: gold yields nothing so it makes more sense to park money in cash – for example very safe government bonds – if you are getting even a modest return on the paper. Owning gold comes with an opportunity cost, which is the amount of money you are losing by not having the same value invested in cash. Now that the Fed is hiking again, gold ought to be losing its lustre as the opportunity cost increases.

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