Examining Gold, Silver ETFs Ahead Of A December Rate Hike

Precious metals and the relevant exchange-traded funds, such as the SPDR Gold Trust (ETF) GLD and the iShares Silver Trust (ETF) SLV, were spared the drama and subsequent negative outcome of higher interest rates when the Federal Reserve stood pat again following its meeting last week.

Well, the drama was shelved for one month at least. There is a growing chorus within the Fed pushing for a rate hike this year. Although one rate hike of 25 basis points is not epic by any stretch, the near-term reaction is likely to negative for gold and silver, which are historically inversely correlated to U.S. interest rates.

A Look Back

Historical data confirm that over the last 45 years, gold performs well when the dollar languishes, is solid when the dollar is flat and loses ground when the greenback gains momentum. There are reasons this relationship exists.

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“Gold appears to be more sensitive to changes in interest rate policy than silver. This is probably because gold is the more truly precious of the two — it is widely used in investment and in jewelry, which can also be seen as an investment,” said S&P Dow Jones Indices in a recent note. “While silver is also used in investment and in jewelry, it is more widely used in industrial and other applications. The reason why gold and silver prices react negatively to higher interest rates may be simple. The metals do not pay interest. As such, higher interest rates tend to make fiat currencies like the U.S. dollar appear more attractive to investors than gold or silver.”

A Look Ahead

Further boosting the case for gold is weak earnings growth in the United States and low and negative yields on sovereign debt throughout the developed world. Said another way, even a couple of rate hikes here in the United States would not be long-term damaging to gold and there are still plenty of developed and emerging economies poised to continue paring borrowing costs, not to mention the many developed nations with negative interest rates.

A traditional reason for embracing gold is its low correlation to other assets, such as stocks and bonds, but investors should still be mindful of periodic increases in those correlations.

“Inflation has been subdued in part as a result of falling energy prices but this won’t last forever, and the core rate of inflation has been perking up. As such, our view is that the Fed will gradually adjust interest rates higher, and that the boost gold and silver prices got from diminished expectations for a rate hike is mainly behind them,” according to S&P Dow Jones Indices.

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