Will The Federal Reserve Send Gold Tumbling?

Monday, May 23, 2016

Gold has had an incredibly interesting year, to say the least. In the beginning of the year, the value of the precious metal skyrocketed, as concerns with regard to China's economic and market conditions took hold. However, recently, we've been seeing declines on the precious metal as the result of overwhelming opinions that the Federal Reserve will increase its interest rate. Today, we'll talk about what the Federal Reserve's interest rate has to do with the price of gold, why investors are concerned that a rate hike is coming, and what a rate hike would do to the price of gold if it did, indeed, happen in June.

What Does The Federal Reserve's Interest Rate Have To Do With The Price Of Gold?

At first glance, it may seem as though the Federal Reserve's interest rate and gold are two completely different topics. While in many respects this may be the case, it is incredibly important that you understand the relationship between gold and the United States Federal Reserve.

Gold, like most commodities, is priced using the United States dollar. As a result, the value of gold can be swayed, in a big way, by movements in the value of the USD. It's a relatively simple concept to understand. The reality is that when the USD increases in value, gold becomes more expensive in nations outside of the United States. Higher costs cause demand for the commodity around the world to fall, leading to declines in price. Adversely, when the USD is declining in value, gold becomes less expensive in nations outside of the United States. The lower cost leads to gains in global demand, and, consequently, increases the price of gold. This is where the Fed's interest rate comes into play.

Since the gold standard was abandoned, the value of currencies has largely been shifted away from the commodity and toward interest rates. Essentially, when interest rates are high, demand for the currency rises, leading to higher values. When interest rates are decreased, the demand for the currency declines, leading to declines in value. Therefore, if the Federal Reserve does increase its interest rate, it will essentially be increasing the value of the USD; and that wouldn't be good for gold.

Why Investors Are Concerned That A Rate Hike Is Coming In June

Back in December, the Federal Reserve increased its interest rate for the first time in nearly a decade. However, that's not the only thing they did. They made a key announcement. The Fed said that it would be looking to increase its interest rate between two and four times in the year 2016. Throughout the beginning of the year, economic conditions simply didn't support an interest rate increase. However, recent inflation data shows that consumer prices grew more in the month of April than we've seen in any month over the past three years. This may give the Federal Reserve the smoking gun (i.e., reason) it needs in order to increase interest rates.

What Would Happen To Gold If The Fed Increased Its Rate?

If the Federal Reserve did decide to increase its rate, it would essentially be increasing the value of the USD. As a result, we would likely see declines in the value of gold. However, these declines wouldn't be likely to last very long. The reality is that global economic conditions are concerning, and market conditions are no better. As a result, investors have been running to gold all year, as a way to keep their money safe. While the Fed may increase its rate, it won't change the fact that global economic and market conditions are causing concern. So, while we will likely see a short-term downward trend, I still see 2016 as being an incredible year for gold investors. 

Joshua Rodriguez

Joshua Rodriguez is an avid financial professional. He is the owner and founder of CNA Finance, a partner at Modest Money, and a writer for US News & World Report, Investing.com, and more! Joshua takes a strong fundamental approach to market analysis and enjoys offering his take on what we can expect moving forward. You can reach Joshua at cnafinancehelp@gmail.com.