The Relationship Between Interest Rates and Gold

This post will obliterate the conventional wisdom and hearsay about the relationship of interest rates and gold. Please understand that humans love to look for relationships that don't change overtime because we hunger to predict. But it is very possible (in fact provable) that relationships between various financial indicators or commodities, such as interest rates and gold, are not constant. Sometimes, years may pass when interest rates and gold are positively correlated and then years may go by with negative or little correlation. Therefore, the relationships lose their predictive value.

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As an example, If you have been an investor for some time, you know the name Robert Prechter, the Fibonacci series wizard who called market turns correctly for many years using the Elliot Wave and for the past several years, using the same indicator, looks like an idiot. What works sometimes does not work all the time.

When considering the relationship between interest rates and gold, here is a recent post found on the Internet in the last 30 days:

So the conclusion is fairly simple. You know that interest rates are going to be pretty low for the foreseeable future. Unless you believe that inflation is going to fall dramatically, you're going to be an environment of low or negative real rates. That has historically been supportive of commodities, particularly gold.

Funny, during most of my life, the relationship that I have observed between and interest rates and gold is just the opposite of what this prognosticator says. Take a look:

The top chart are yields of 3 month, 6 month and other Treasuries, the bottom chart, shows the spot price of gold. So, in general, interest rates and gold prices appear to be positively correlated, thereby refuting the above expert's prediction that low interest rates correlate rising gold prices. While he may be correct, the past does not support his indicated relationship between interest rates and gold prices.

I would argue that the relationship is far more complex because:

there are other variables to consider (e.g. the domestic inflation rate, the trend of the US currency value, etc.)
the reasons that interest rates are rising or falling (recession or Fed manipulation)
the reasons that gold prices are rising or falling (e.g. supply and demand)

By the way, here's a prognosticator that believes interest rates and gold are postively correlated and he is just waiting for interest rates to rise to boost his gold fortunes.

Postscript: As of May 25 2012 interest rates are hitting the all time lows of my lifetime (I am 56). At the same time, Gold is in bearish territory. And thus, we see that low interest rates are not the determinant of gold prices. A great lesson is to always ignore investment prognosticators that corrleate one variable as the causal variable for the price of a security or commodity. These one-to-one relationships sometimes hold true but they are not the permanent rule.