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Gold Bounces Despite Fed Rate Rise

The gold price rose 2.3% to $1,230 yesterday after the Federal Reserve raised interest rates in the US amid signs that inflation is moving higher

Karen Kwok 17 March, 2017 | 10:51AM

The gold price rose 2.3% to $1,230 yesterday after the Federal Reserve raised interest rates in the US amid signs that inflation is moving higher. The gold price reaction was a surprise; in general when interest rates rise, the price of the precious metal will fall. This is because rising rates are a sign of a healthy economy, and gold is used as a hedge against recession and uncertainty.

But today gold price has its eye on the bigger picture – and investors are turning to the yellow metal in anticipation of that great destroyer of value; inflation.

Even with two rate rises in the last four months, the Fed's real rate of interest has in fact declined, dropping from -1.5% to -1.7% when you factor in rising inflation, said Adrian Ash, head of research for BullionVault, the UK-based online trading platform.

“That means the dollar is losing value at a quicker pace, even as Janet Yellen tries to talk tough. If the Fed can smell inflation, then gold will certainly know about it too. That's why, since 1986, gold has been more likely to rise if rates go up than if they stay the same, and by a greater percentage as well,” said Ash.

Ash added that when looking at the long term, a US interest rate rise has also been followed by much stronger gold gains than a cut, and more frequently too.

European Investors Back Gold

Another support to the gold priced is the fact that interest rates around the world remain very low, especially in Europe, said Juan Carlos Artigas, director of investment research with World Gold Council.

“For investors in regions outside the US, the opportunity cost of holding gold remains low and the risk of uncertainty is high due to the political cycles in Europe. Therefore, many of them are using gold to hedge against the risk,” said Carlos Artigas.

There are more European investors using gold-backed exchange-traded funds as a tool in their portfolios to mitigate risks than before.

“When you look at last year, more than half of the demand for gold-backed ETFs came from Europe. Despite there were some outflows from Europe towards the end of the year they were pretty muted. European investors are very important and they occupied main shares of inflows in gold-backed ETFs,” said Carlos Artigas.

Data provided by Morningstar Direct revealed that in Europe, precious metals ETFs recorded €12 billion inflows in 2016, the highest inflows in eight years. For first two months of this year, together commodities precious metals ETFs saw €2.7 billion inflows. In November last year, the sector saw €647 million outflows.

Choose ETFs Rather than Mining Shares

The commodities rally may have lifted up the share prices of gold mining companies, but Andrew Summers, Investec Wealth & Investment, says investing in ETFs that track physical gold is a better way to invest in the yellow metal.

“Even when the gold price is doing very well, shares of gold miners could fall, because the company management is no good or they are overleveraged. The downside of investing in gold miners is that if you are trying to get gold exposure via equity market, you have equity market correlation. Also although the performance of a fund that invests in gold mining stocks will have some correlation to the gold price, it will also have a lot of correlation with the equity market,” said Summers.

Two ETFS for Picking Up Low Cost Gold

For investors who are looking to purchase ETFs that back physical gold, Morningstar passive analyst Kenneth Lamont suggested two products in the market.

They are Source Physical Gold P-ETC and ETF Securities Gold Bullion Securities ETC. Lamont said Source Physical Gold P-ETC is an impressive product with very tight spreads.

For those who want that extra layer of security, they may look at the ETF Securities Gold Bullion Securities ETC, which goes one stage further and allows investors to physically access that gold if necessary at some point in the future, said Lamont.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
ETFS Gold Bullion Securities ETC122.34 USD-1.46-
Source Physical Gold P-ETC126.19 USD-1.47-
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk