When interest rates are low, the “opportunity cost” of owning gold (in any form) falls dramatically. As interest rates rise, greater opportunities for return occur and the price of bullion falls away.
A perfect example of this occurred during the stock market crash of 1987. As the market collapsed, gold sold off nearly eighteen percent over the following years. Primarily because investors liquidate anything to raise cash to cover losses as interest rates shot up. From October 1987 to October 1989 the Bank of England base rate rose from nine percent to fifteen percent. Gold bullion fell thirty one percent, from $481 to $366 per ounce.
More recently, since the beginning of 2011, central banks have leaked rumours that interest rates are going to rise and gold fell. As soon as the deceit was exposed as not practical, the yellow metal rose again. Then our old foe Colonel Gaddafi began to be naughty, and tarting with Egypt gold fell from $1440 to under $1400. So panic does drive gold, put it is not why you should own it.
I am not a trained economist but I can add, subtract and multiply with the best of them. The probability interest rates will rise anytime soon is slim. In fact, as the economy continues to struggle, there is a chance that the Bank of England could start Quantative Easing two (QE2). Considering the fact that in the USA QE2 has done very little to boost anything except the stock market, economist Willem Buiter has some interesting thoughts on what could come next.
Formerly head of the London School of Economics and member of the Bank of England monetary policy board, Buiter is now chief economist at Citibank, one of the largest in the “too big to fail” set.
In several papers Buiter has advocated that central banks “go negative” with interest rates, and instead of paying interest they charge to deposit money. This would be a bold move and most probably signal the end of coins and notes in circulation.
If a central bank goes negative interest rates, any savings we have must be used or we lose it. In practice, this would mean if you did not spend your money, you would lose even more than we do today through inflation. Our first defence would be cash hoarding, and that would lead to notes that had a use by date. If the use by date proved ineffective in forcing us to buy junk we did not need, then cash could disappear completely. Further, since anybody with any sense would buy quality assets, lead by gold, the likelihood is that gold would become illegal - again.
