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A rise in Rates is Bad for Gold but Not for Stocks, Initially

David Becker
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A rise in Rates is Bad for Gold but Not for Stocks, Initially

When short-term rates begin to rise at the beginning of an economic expansion the increase in rates is initially not bad for stocks. When the market and the economy are weak, the Fed lowers short-term rates to try to stabilize things. The two-year yield plunged between 2000 and 2002 while the stock market fell. The same thing happened during 2007 and 2008. Falling short-term rates coincided with falling stock prices when an economy is contracting.

Short-term rates turned up with stocks in 2003 and rose with them until 2006. That would seem to suggest that rising short-term rates are good for stocks. So why is everyone so concerned about the Fed’s raising of short-term rates? Since 2009, the S&P 500 has surged to record highs, while the two-year yield has remained relatively low. That is because of the Fed’s unusually loose monetary policy. The two-year yield would have to rise to 1.5% just to get back to where it was at the 2003 bottom. It would have to reach 5% to get back to where it was in 2006.

There is no question that the Fed’s keeping both short and long term rates at historically low levels has helped fuel the move into higher-yielding stocks. A rate hike might cause some nervous profit-taking in stocks. Given how low short-term rates are, however, history suggests they would have to rise a lot to sidetrack the secular bull market in stocks.

Gold on the other hand is non-yielding asset. As a result, it thrives when rates are low and falling. That was the case earlier in the last decade, and again after 2007. The plunge in short-term rates during 2007 helped the bull market in gold to continue. The bottom in the two-year yield in late 2011 coincided exactly with a peak in gold. The rise in short-term rates since then has corresponded with falling gold prices. Rising rates should continue to weigh on the precious metal.

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