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It is no secret that the commodity markets don’t adhere to strict valuation principles, such as those observed in the equity and fixed income markets. Thus, whenever there is a macro-level change, or expected change, a wide variety of anecdotal arguments are floated by traders/investors regarding how such changes will impact the price and risk of commodities. This work, nonetheless, utilizes scientific methods rather than speculation to answer the subject question:
This work evaluates how rising interest rates or periods of elevated rates impact the returns and risk of gold, silver, & crude oil WTI. Scientific methods are utilized for the analysis, and the results are conveyed without any ‘jargon’ to enable easy comprehension. Furthermore, advance metrics such as risk-adjusted returns and downside or crash risk are also examined. So, without further ado, let’s get straight into the results.
(Related question answered: Why do central banks raise or lower interest rates?)
How rising interest rates affect the price/returns of gold (XAUUSD), silver (XAGUSD), and crude oil (WTI)
In this work, last half-century of periods of rising interest rates & their impact on the subject commodities is compared with long-term performance.
Gold
Table 1. XAUUSD performance
Long-term monthly performance of XAUUSD:
Gold (XAUUSD) has yielded a nominal return of 0.52% per month, long-term; during periods of rising and elevated rates, the returns of gold—overall—declined by -123%, which is a -1.46 standard deviations difference from the long-term mean. Moreover, the volatility of returns (measured by standard deviation), overall, declined by -10.1% during such periods.
Thus, on the face of it, one may conclude that rising rates impact gold returns negatively; however, for definitive and thorough answers, hypothesis testing (statistical tests) is utilized in this work. Statistical tests reveal that the difference in the returns and risk of periods of rising rates compared with the long-term performance—though sizable—isn’t statistically significant.
Nevertheless, the net risk-adjusted returns (a critical parameter—discussed below) are impacted.
Silver
Table 2. XAGUSD/SL performance
Long-term monthly performance of XAGUSD/SL:
Silver (XAGUSD, SL), long-term, has yielded 0.75% nominal returns monthly; during periods of interest rate rises/elevation, silver’s returns declined -137%, overall (as per weighted mean); this weighted mean of periods of rising rates is -2.02 standard deviations away from the long-term mean. Volatility declined by -10.2%. Here again, on the face of it, the results depict a considerable impact.
However, as per hypothesis testing, the difference isn’t statistically significant.
This is because the chance of a lower observed mean being a chance occurrence is high; because silver’s long-term volatility is high, and the p-value of the test is high, if we accept that silver’s returns are impacted by the factor analyzed, the probability of making an error would be considerable (20.24% likelihood that we get the observed mean).
Nonetheless, net risk-adjusted returns are impacted meaningfully.
Crude oil WTI
Table 3. crude WTI/CL performance
Long-term monthly performance of crude WTI/CL:
WTI has yielded a long-term monthly return of 0.76% long-term; overall, during periods of rising/heightened interest rates, WTI’s has generated 21% higher returns than the long-term mean. WTI’s volatility during such periods has been very much identical to long-term volatility.
Hypothesis testing reveals that the difference in returns and volatility isn’t statistically significant.
Summary of results of returns and risk (volatility)
While periods of rising interest rates have impacted the performance of XAUUSD, XAGUSD, & WTI, hypothesis testing confirms that the effect isn’t statistically significant when compared with long-term performance when it comes to nominal returns & risk; risk-adjusted returns are impacted meaningfully, however.
Investors/traders should be aware that the performance of the aforementioned three main commodities is likely to be poor as rates rise or remain at elevated levels, when compared to previous periods.
Overall, for every one month of hawkish policy by the FED, as per the data, we can expect gold to decline marginally (approx. -0.12% pm), silver by about -0.283%. Risk (volatility) isn’t likely to be impacted meaningfully & the value at risk VaR isn’t likely to experience a significant increase; however, if the subject commodity is at an elevated price when the central bank takes a hawkish turn, there is a possibility of market apprehensions rising, which can—in theory—lead to a price crash.
VaR explained:
Furthermore, there is one more parameter of critical importance—the risk-adjusted returns
What is the Sharpe ratio:
While returns are important, net returns (i.e., returns minus risk-free rate), when considered in relation to the risk assumed by investing, are substantially more important. An asset’s price may appreciate at 10% long-term, however, if during certain periods, the risk-free rate rises to, say, 5%, and the volatility of the asset increases substantially, we cannot consider the performance of the asset as being within the bands of the long-term performance range, because of net returns, considering the risk, being substantially lower due to increased risk-free rate.
We must evaluate the price performance of the subject commodities via the Sharpe ratio to examine how net returns per every unit of risk are affected by rising/elevated interest rates.
Table 4.
While the Sharpe ratio of WTI—overall—appears to be unaffected by rising rates, this parameter for gold and silver, however, exhibits considerable difference when compared to the long-term value.
The Sharpe ratio of gold & silver (in that order) during the last half-century declined by -2896% & -587% during periods of rising/elevated rates. This has extensive implications for trading/investing decisions in the two precious metals if a hawkish turn by the central bank is possible.
Overall, during such periods, gold yielded -$0.18 net return per every unit of risk; this value for silver stands at $-0.13.
This simply means that during periods of hawkish policy by the FED, as per the data, it does not make financial sense to hold precious metals (XAUUSD, XAGUSD). These precious metals yield negative net returns per every unit of risk—and thus, continuing to hold these metals during such periods is likely to be antithetical to the principle of preservation/protection of capital. Holders earn a negative return per every unit of risk assumed, and that, put simply, is a bad deal.
See also:
How Much Can Metals, Energy, & Grains Fall In a Market Crash? | Which Is the Best Commodity to Hold?
Results of statistical tests
Table 5. Results of pooled variance tests:
Table 6. Results of F tests: