Interest Rates and the Effect on Gold and Silver Spot Price Movement

There’s a commonly held belief among investors that as interest rates rise, the prices of precious metals such as gold and silver drop. Likewise, as interest rates fall, investors expect spot pricing for gold and silver to increase.

At first glance, this would seem to make sense. After all, rising interest rates would make fixed-income investments such as money market funds and bonds more attractive (and vice versa).

However, although changes to the benchmark interest rate set by the Federal Reserve — known as the federal funds rate — often cause knee-jerk short-term movements in the spot pricing of gold and silver, there’s little evidence to show that interest rate fluctuations have a long-term effect on the value of precious metals. Instead, prices for gold and silver have generally been on the rise regardless of interest rate increases.

In this article, let’s examine some of the dynamics at play when it comes to interest rate movements and changes in the cost of gold and silver.

Why Interest Rates Change

There are several different factors that can influence interest rates. These include the forces of supply and demand. When there is plenty of demand for loans, banks and other lenders can set higher rates, making the costs of borrowing more expensive. On the other hand, banks may lower the interest rates on products in order to attract borrowers when demand for loans decreases.

However, the federal government also plays a major role in interest rate fluctuations. That’s because the Federal Reserve — the nation’s central bank — can attempt to steer the economy by changing the federal funds rate. The fed funds rate is the base rate at which banks and other financial institutions lend money to each other overnight. This influences lenders to raise or decrease interest rates on their products.

This fed funds rate has been in the news often since March 2022, when the Federal Reserve’s policy-setting branch, the Federal Open Market Committee (FOMC), started its most recent cycle of rate hikes. The FOMC began hiking rates in an effort to quell rampant inflation that followed the COVID-19 pandemic. The Fed’s logic is that higher interest rates discourage borrowers from taking out loans for big purchases such as homes or cars, as well as from using their credit cards. In turn, this should cool down consumer demand and, thus, high prices.

Following the FOMC’s March 2022 rate hike, the committee raised its benchmark rate 11 times until its July 2023 meeting. Since that time, the FOMC has held its base rate steady in a range of between 5.25% and 5.50% — a 23-year high.

The Historic Impact of Interest Rates on Precious Metals

One of the most notorious examples of interest rate hikes occurred between 1977 and 1980. In an effort to cool down the “Great Inflation” in which prices rose by the double digits of percent, the FOMC aggressively boosted its base rate. This policy sent the fed funds rate to a high of more than 20% in 1980.

However, this did not depress the price of silver and gold. In fact, the spot price of gold — the rate at which the precious metal could be bought “on the spot” or at that exact time (as opposed to in the future) — soared to a then-all-time high north of $850 per troy ounce. Likewise, the spot price of silver reached a new high of $49.45 per troy ounce in January 1980.

A similar scenario has played out recently during the Fed’s most recent attempts at cooling inflation. Although the spot pricing of gold dropped to a bottom of around $1,630 in the second half of 2022, it has since risen to higher than $2,300 per ounce.

That’s not to say that the spot prices for precious metals don’t fluctuate shortly before or after FOMC decisions. However, over the long term, there’s little evidence of any correlation between the long-term price direction of gold and silver and interest rate adjustments.

Instead, spot prices for precious metals are influenced more by geopolitical and economic events that have a negative effect on the spending power of the dollar. Gold and silver have traditionally been used as a hedge against a deteriorating dollar. This explains why rising inflation tends to drive the spot prices for gold and silver higher.

Possible Interest Rate Movements in the Next 18 Months

Although no one can see into the future, it’s safe to say that the Federal Reserve is finished with its current anti-inflation rate-hiking regime. There has been enough evidence that the FOMC’s hawkish policies have succeeded in slowing inflation.

However, the question now is when the FOMC will begin cutting its benchmark rate.

At the start of the year, the CME Group’s FedWatch Tool indicated that the futures markets were expecting the FOMC to announce as many as six 25-basis-point rate cuts in 2024. However, remarks from Fed Chair Jerome Powell and other central bank officials have lowered the market’s expectations to just one or two rate cuts before the year is done.

Many economists, including the analysts at Kiplinger, now expect the Fed to continue lowering rates into 2026. However, it’s unlikely that rates will return to their COVID-era low of 0% to 0.25%.

Long-Term Gold and Silver Investments

No matter what tweaks the Federal Reserve makes to its fed funds base rate, we can expect the value of precious metals such as gold and silver to rise. Instead of worrying about spot prices for gold and silver, savvy investors understand that holding precious metals for the long term is the smart approach to building and preserving wealth over time.

Just as holding onto legacy stocks as an investment, rather than day trading speculative stocks, is the more reliable method for stable gains, the same goes for long-term precious metal investments versus spot price trading.

Although nothing is a given in the world of investing, the long-term stability of precious metals has been proven historically as something you can count on. That’s especially the case as geopolitical uncertainty and dollar instability continue to be threats.

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