Will Interest Rate Increase Cause Gold To Plunge In 2021?

The decline in the real interest rates is the most important downside risk for gold. Will it materialize, plunging the price of the yellow metal?

The rise in inflation is the most significant upside risk for gold this year, but there are also a few important downside risks. The most disturbing for us is the possibility that the real interest rates will increase. Why? Please take a look at the chart below.

As you can see, there is a strong negative correlation between the real yields and gold prices. When the interest rates go up, the yellow metal falls, and when the rates go down, gold rallies. Indeed, the real interest rates peaked in November 2018 at 1.17 percent, just one month before the last hike in the Fed’s last tightening cycle. Since then, they were falling, reaching their historical bottom below -1.0 percent in the summer of 2020. Not coincidentally, gold was experiencing a bull market during this period, reaching its record high of almost $2010, just when the rates bottomed. And, as the rates normalized somewhat, the price of gold corrected to the level below $1,900.

Now, the obvious question is whether there is further room for real interest rates to go down. In 2019, they were falling amid the economic slowdown and the dovish Fed cutting the interest rates. Last year, they plunged even further (with a short spike because of the surge in the risk premium), as a result of the COVID-19 related economic crisis and the U.S. central bank slashing the federal funds rate to practically zero.

However, the Great Lockdown and resulting deep downturn are behind us. When we face the second wave of the pandemic and people become vaccinated, there will be an economic recovery. As well, the Fed has already brought the interest rates to zero – meaning that without the U.S. central bank implementing NIRP, the nominal policy rates reached their lower bound. So, assuming that the Fed will not cut interest rates further and that investors will not expect a further slowing down of the economy, the room for further declines in the real interest rate is limited.

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it ...

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