The rate-cut cycle is approaching, how can gold investments ride the waves? [A must-read for individual investors in the US stock market]

Many friends have asked me how I view gold and how it performs during an interest rate cut cycle.

Today, this article will focus on gold.

The Federal Reserve’s interest rate cuts typically have a significant impact on the price of gold. Here are several key factors of how the Federal Reserve’s interest rate cuts affect gold:

1. Relationship between Interest Rates and Gold Prices

• Decrease in Interest Rates:

• When the Federal Reserve cuts interest rates, real interest rates (nominal interest rates minus inflation rate) usually decrease.

• In a low-interest-rate environment, the opportunity cost of holding interest-free assets like gold decreases, making gold more attractive.
  
• Investors may shift from low-yield bonds and savings to alternative investments like gold.

2. Relationship between the US Dollar and Gold Prices

• Weakening of the US Dollar:
  
• Rate cuts typically lead to a depreciation of the US dollar as low interest rates reduce the attractiveness of holding US dollar assets.
  
• Since gold is priced in US dollars, a weaker US dollar makes gold priced in other currencies cheaper, increasing global demand and driving up the price of gold.

3. Inflation Expectations

• Inflation Protection:

• Federal Reserve rate cuts may lead to market expectations of future inflation rising.

• Gold is seen as an effective hedge against inflation because its value typically does not depreciate with inflation.

• Investors often increase their demand for gold when they anticipate rising inflation, thereby driving up its price.

4. Market Risk Aversion

• Increased Safe-Haven Demand:
  
• Rate cuts are often a measure to address economic weakness, which may increase uncertainty about economic prospects in the market.

• During periods of economic uncertainty, investors tend to seek safe-haven assets. The demand for gold as a safe-haven asset increases, pushing its price higher.

5. Global Market Impact

• International Capital Flows:
  
• Federal Reserve rate cuts can affect global capital flows, potentially leading to capital outflows from the US seeking higher-yielding markets.

• Such capital flows may increase demand for gold, especially in times of heightened global economic uncertainty.
  
• Gold is anchored to real interest rates at the medium to long end, and it has a negative correlation with real interest rates at the medium to long end. Gold’s ability to hedge against inflation is due to the fact that high inflation and risk events will lower real interest rates, leading to an increase in the price of gold. The negative correlation between the US dollar index and gold is also linked to the implied real interest rates at the medium to long end reflecting economic prospects.
  
• Based on the calculation using the real interest rates derived from TIPS bonds of various maturities and the Breakeven Inflation (BEI) index, it is found that gold has the highest correlation with the 10-year real interest rate and the lowest correlation with real interest rates below 5 years. Therefore, in research, it is common to see comparative analysis between the 10-year TIPS Treasury bonds and the price of gold (in a negative correlation).

• The real interest rate can be used to assess the price trends of assets such as gold and Bitcoin. Similarly, in the past two years, the United States has also experienced a cycle of real interest rate changes. Before the epidemic, the economic outlook was bleak, with both nominal and real interest rates declining.

• At the beginning of 2020, the sudden outbreak of the epidemic caused the nominal interest rate in the United States to plummet. However, with the implementation of fiscal stimulus plans and cash subsidies, the demand curve did not shrink significantly. Instead, the inflation level rose due to consumption driving it. The divergence between the downward nominal interest rate and the upward inflation rate resulted in extremely low real interest rates, giving rise to a super bull market for virtual assets. In 2020-2021, there was an epic bull market for virtual assets, and gold also performed well.

Let’s review some historical performances of gold:

During the 2008 financial crisis:

• The Federal Reserve significantly cut interest rates and implemented quantitative easing policies, leading to a decrease in real interest rates and a weakening of the US dollar.

• The price of gold rose from around $800 per ounce at the end of 2008 to around $1900 per ounce in 2011, demonstrating the significant impact of rate cuts on gold prices.

During the 2020 COVID-19 pandemic:

• The Federal Reserve lowered interest rates to near zero and implemented large-scale quantitative easing policies to address the economic impact of the pandemic.

• The price of gold reached a historical high in August 2020, nearing $2100 per ounce, reflecting the support of rate cuts and economic uncertainty on gold prices.

Investment strategy recommendations:

Increase gold allocation:

• During expected or actual rate-cutting cycles by the Federal Reserve, increasing exposure to gold can serve as an effective strategy to hedge against inflation and market uncertainty.

• Investors can gain gold exposure through direct purchases of physical gold, gold ETFs, or gold mining stocks.

Diversify investments:

• In addition to gold, investors may also consider other precious metals such as silver and platinum to further diversify portfolio risks.

• Maintain a diversified asset allocation to ensure some level of returns and risk mitigation in different market environments.

Monitor economic indicators:

• Closely monitor the Federal Reserve’s policy direction, interest rate changes, and inflation expectations.

• Based on economic data and market dynamics, adjust investment portfolios promptly to ensure flexibility in responding to changes in interest rates and inflation environments.

Below are some recommended gold and precious metals ETFs worth considering, covering pure gold investments as well as diversified portfolios of various precious metals:

Gold ETF:

1. SPDR Gold Shares (GLD): This is one of the most popular gold ETFs, directly tracking the spot price of gold, suitable for investors looking to invest directly in gold.

2. iShares Gold Trust (IAU): Another major gold ETF with lower fees, also directly tracking the spot price of gold.

3. Aberdeen Standard Physical Gold Shares ETF (SGOL): This ETF also invests directly in physical gold with lower management fees, suitable for long-term holding.

Silver ETF:

• iShares Silver Trust (SLV):
  • Invests directly in physical silver, suitable for investors optimistic about the silver price trend.

• Aberdeen Standard Physical Silver Shares ETF (SIVR):
  • Another major silver ETF that invests in physical silver with lower management fees.

Platinum and Palladium ETF:

• Aberdeen Standard Physical Platinum Shares ETF (PPLT):
  • Directly invests in physical platinum, suitable for investors optimistic about the platinum price trend.

• Aberdeen Standard Physical Palladium Shares ETF (PALL):
  • Directly invests in physical palladium, suitable for investors optimistic about the palladium price trend.

Precious Metals ETF:

• ETFS Physical Precious Metals Basket Shares (GLTR):
  • This ETF invests in a basket of precious metals, including gold, silver, platinum, and palladium, providing diversified exposure to precious metals.

• iShares MSCI Global Gold Miners ETF (RING):
  • Invests in major global gold mining company stocks, suitable for investors looking to benefit from the rise in gold prices through mining stocks.

• VanEck Vectors Gold Miners ETF (GDX):
  • Primarily invests in gold mining companies, offering broad exposure to mining stocks, suitable for investors optimistic about gold prices and mining company prospects.

• VanEck Vectors Junior Gold Miners ETF (GDXJ):
  • Primarily invests in small and mid-sized gold mining companies, with higher risk but potential for higher returns during gold price increases.

Leveraged Bull ETFs (relatively aggressive):

• Gold ETF – PowerShares DB Gold Double Long (DGP)

• Gold ETF – ProShares Ultra Gold (UGL)

• Silver ETF – ProShares Ultra Silver (AGQ)

Investment Strategy Advice:

• Risk Tolerance: For investors with lower risk tolerance, they can choose ETFs that directly track the prices of gold or silver (such as GLD or SLV). For those with higher risk tolerance, they can consider mining company ETFs (such as GDX or GDX).

• Diversification of Investment Portfolio: If you wish to spread investment risks, you can choose a comprehensive precious metals ETF (such as GLTR) or diversify your funds into different precious metals ETFs.

When selecting ETFs, it is important to evaluate based on your own investment objectives, market expectations, and risk tolerance.

A rate cut by the Federal Reserve typically has a positive impact on the price of gold, as it lowers real interest rates, leads to dollar depreciation, increases inflation expectations, and boosts market demand for safe-haven assets, driving up the price of gold. During a Federal Reserve rate-cutting cycle, investors may consider increasing their gold allocation as an effective hedge against economic uncertainty and inflation risks. Maintaining diversification and dynamically adjusting your investment portfolio are important strategies for achieving stable investment returns in a complex market environment.

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Disclaimer: The content of this text is for reference only and does not constitute investment advice. Investing involves risks, so caution is advised when entering the market.