What More Interest Rate Cuts Will Do to the Price of Gold
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The Federal Reserve cut interest rates for the second time this year on Nov. 7, 2024, and the central bank is largely expected to do so again tomorrow as its December meeting concludes.
While it’s unclear how much the Fed will lower the benchmark effective federal funds rate, it’s likely that more cuts are in store in 2025. Drops in interest rates significantly impact financial markets, but how will lower rates affect the price of gold?
How interest rates affect global markets
Interest rates dictate the cost of borrowing money. Lower interest rates make it easier for individuals and businesses to take out loans, which put more money into the economy. Companies can hire more people and make more investments with the extra cash. Lower interest rates also help consumers buy more products and services.
Increased consumption leads to inflation, as companies will raise their prices based on heightened demand. That’s good news for many investments, such as stocks, real estate and gold, since lower interest rates increase the value of each of these assets.
However, higher interest rates have the opposite effect. Interest rate hikes may become necessary if inflation runs out of control, as we saw in 2022. Higher rates discourage businesses from making additional investments and cause consumers to tighten their budgets. High interest rates reflect a contractionary monetary policy and reduce inflation. Asset prices tend to fall when interest rates go up.
What lower interest rates mean for gold
Lower interest rates are favorable for gold since they increase the money supply. More dollars chase fewer goods and services, causing currencies to lose their value. Gold retains its intrinsic value, which means investors need more dollars to buy the same asset.
Lower interest rates raise asset prices. However, gold has fewer variables than stocks and real estate. Inflation and the level of uncertainty are two driving forces that impact gold prices. Stocks and real estate have those factors as well, but investors also have to consider factors like corporate earnings, property market valuations and other variables.
For some asset classes and individual investments, other issues can minimize the impact of lower interest rates. Meanwhile, gold is always positioned to gain value when interest rates decline.
Does gold always go up when interest rates go down?
In most cases, gold will gain value as interest rates drop. We’ve seen that this year, as gold is up more than 30% in 2024.
However, lower interest rates are only one variable. While they are a good tailwind for gold, lower inflation rates can act as a headwind that cancels out the gains from lower interest rates. Inflation has dropped significantly since 2022 and sits at 2.7% as of November 2024 (December’s inflation reading won’t come out until January).
Interestingly, gold remained flat in 2022 despite record inflation, which demonstrates that changes to interest rates and inflation can cancel each other out and minimize gold’s price movements.
Gold can also lose value if economic or geopolitical issues start to ease, as the precious metal is viewed as a safe-haven asset that provides investors with stability during uncertain times. However, the opposite is also true, as gold may underperform stocks and real estate during less tumultuous times.
Should investors buy gold?
Investing in gold can be a prudent move for investors who want to hedge against inflation and diversify their portfolios. Many experts recommend having 5%–10% of your portfolio allocated to alternative assets, including gold. Precious metals, despite being considered safe-haven assets, still have risks; however, their lack of correlation with the stock market gives investors an advantage.
Gold gains can minimize the impact of a stock market correction. Furthermore, the precious metal is poised to gain value as interest rates decline. Gold also appreciates each time the Fed decides to print more money, as devaluing paper currency results in comparative gains for the yellow metal.
Investing just 5%–10% of your portfolio in gold gives you the flexibility to pursue asset classes, like stocks and real estate, that can outperform precious metals during bull markets. Additionally, those two aforementioned assets can also generate income via dividends and rental income, which becomes valuable cash flow that can eventually replace your income as you age.
However, unlike many other assets, gold has withstood the test of time. It’s been a medium of exchange for thousands of years, and it’s an essential resource for many industries. It’s used in automobiles, smartphones, dentistry and other products and services. Societies would have a difficult time functioning properly without gold.
Investors also have the option of opening a gold individual retirement account — or gold IRA — to capitalize on tax benefits. You can reduce your current tax bill with a traditional gold IRA or avoid taxes on any capital gains with a Roth gold IRA. These retirement accounts can help you build a nice nest egg with alternative assets to complement your traditional retirement accounts by the time you retire.