It’s almost a cliche in the investment world: Rising interest rates and higher gold prices aren’t supposed to get along. The reasons are seemingly clear: As interest rates head higher, the widespread perception is that gold—which doesn’t pay any interest—can’t go along for the ride.
And because it can’t go along for the ride—can’t generate those higher payouts—investors are inclined to look elsewhere. That’s what is supposed to happen, anyway. But the funny thing here, in later 2007, is that interest rates are up—the latest cut is the first since July of 2003, in fact—but gold’s been up, too, and has been since 2001.
So much for investment cliches.
It’s Not the First Time, Either
This cliche-busting phenomenon of rising interest rates and rising gold has happened before, of course. It was back in the 1970s. You remember those days of “oil shock,” Jimmy Carter’s smarmy smile, Iran and Afghanistan? Well, after the overthrow of the Shah in late ’78. Iranian oil, formerly a safe bet for the US, took a drastic production cut from 5.2 million barrels in ’78 to just 1.7 million barrels in ’80.
Oil prices in the US soon rose 30 percent to $9 a barrel in ’78. Inflation followed right on its heels, jumping to a hefty 9 percent. Trying to catch up, the prime rate climbed as well, hitting nearly 12 percent—at the exact same time gold crossed the $200/oz barrier for the first time ever.
Just a year later, oil spiraled higher to $12.64 for another 40 percent jump. And everything else, not unexpectedly, followed: Inflation rose to 11 percent, interest rates hit a jaw-dropping 15.25 by year’s end, and gold crossed first the $300, then the $400 barrier, hitting $455 on its way to averaging $306/oz for the year.
But That Just Set The Stage For The Thrilling 1980 Climax
In 1980, oil prices reached $21 a barrel due in large part to Iran invading Iraq. Accordingly, that spurred inflation to an “official” 13.58 percent. The prime answered with an almost loan shark 20 percent on April 2nd. And gold? It hovered in the $500 vicinity on that same April 2nd day, after setting the current $850/oz record on January 21st (thereby smashing the $500, $600, $700 and $800 barriers in one fell swoop).
So both gold and interest rates set nearly simultaneous records.
Then came the late 80s.
In ’87 and ’88, interest rates responded to higher oil and inflation by rising from 7.75 to 10.5 percent. Meanwhile gold followed suit, jumping $100 (from $390 to $499).
Interesting picture. Are we now seeing that same picture today?
What’s “Supposed” to Happen Isn’t Happening
What’s supposed to happen today with the price of gold has to do with the difference between interest rates and inflation.
When interest rates are lower than inflation, gold is supposed to be considered a good investment. When rates are significantly higher than inflation, though, borrowing is considered “expensive”— if the rate were 9 percent and inflation were 3.5 percent, for example, the resulting 5.5 yield would be regarded as “high.” Conventional wisdom says it’s during just such times that the price of gold is supposed to go south.
Yet with the prime currently at 8.25 percent and the “core” inflation rate (which is, ridiculously enough, minus the everyday essentials of energy and food) at under a measly 2 percent annual pace, the resulting yield should be high enough to put gold back on its heels. It hasn’t. While gold has been a bit range-bound of late, it shows no signs of heading south.
In fact, as mentioned earlier, it’s been up strongly, impressively, over six years now.
So…either this “rising interest rate theory of avoiding gold” is just a bunch of hooey…or, as in the late 70s, inflation really is a lot higher than its officially being pegged.
When Inflation, Interest Rates AND Gold Go Up At the Same Time
According to the Federal Reserve Bank of Dallas, “nine of the ten post-World-War-II recessions were preceded by sharply rising oil prices.” And that’s despite any tactics the Fed did or didn’t employ.
Higher interest rates are certainly no panacea. There can be so much weakness inherent in the economy, so much “oil shock,” so much debt, so much doubt, that higher rates simply fail to gain the expected traction (unless it’s to demolish the real estate market).
When the majority of people notice the inability of higher rates to calm the economy, when they witness raging inflation in their everyday purchases —something that isn’t, as in the 70s, reflected by “official government statistics”—then their attention can be drawn to other means of financial security. Like precious metals. And that can be what’s accounted for gold’s 6-year bull run.
Hopefully, we won’t follow that startling post-World War track record and suffer a serious recession just up ahead. But whether we do or not, your job is to protect your family, yourself and your hard-earned assets in the best way you know how.
Now I realize that rates are on the verge of being cut to save the floundering housing industry. But, whether the interest rates are rising or falling, it’s not hard to see that the kind of financial security most of us seek comes in a gleaming, beautiful form.
You’ve seen him on Fox News Television and heard him on the Rush Limbaugh Show. He’s a published author, writer and an expert guest on more than 1000 radio programs discussing today’s economy and gold.
Kevin DeMeritt, President of Lear Financial, is a nationally renowned analyst whose insight into the future of domestic and global economies is unmatched.
His book, The Bulls The Bears and the Bust, reviewed by the Associated Press, predicted the market crash of 2001 and the ensuing rise of gold to the status of best investment.
Now more than ever, his insights are welcome by nervous investors.
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