Why you should invest in gold with interest rates paused

Interest rates have been on a wild ride over the last couple of years as the Federal Reserve has worked to battle stubbornly high inflation. After keeping rates near zero during the pandemic to help stimulate the economy, the Fed started aggressively hiking its benchmark federal funds rate in March 2022 to try and get rising consumer prices under control.

The federal funds rate now sits in a range of 5.25% to 5.50%, the highest level in 23 years. And, while the Fed rate hikes have helped cool inflation compared to its peak of 9.1% in June 2022, inflation has started to tick back up recently. After hitting an annual rate of 3.2% in February, consumer prices rose 3.5% in March compared to a year earlier.

So, with inflation still running too hot, the Fed announced at its May 1 meeting that it would keep its benchmark rate paused for now. That's bad news for borrowers, who aren't likely to see lower loan rates in the foreseeable future. But while you may want to rethink your borrowing strategy in light of today's news, there is one smart move to consider making while interest rates are paused: investing in gold. Below, we'll detail why.

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Why you should invest in gold with interest rates paused

With the high interest rate environment likely to persist for now, investors would be wise to consider adding gold to their portfolios for several key reasons, including:

Gold tends to thrive while interest rates are high

You might think that higher interest rates would be bad for gold since it doesn't pay any interest or dividends like bonds or stocks. However, the opposite is often true. Gold has historically done well when rates are high.

The key reason is that the Fed keeps interest rates high when it's worried that inflation is getting out of control and wants to slow down the economy. And, while rapidly rising prices erodes the purchasing power of paper money, gold tends to hold its value over the long run.

So, when the Fed is hiking rates to fight inflation, many investors start looking at gold as a safe haven to protect their wealth. They want an asset that will maintain its buying power instead of cash that is losing value daily due to high inflation.

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Gold provides diversification for portfolios

When the economy is going through a rough patch, like during periods of high inflation and elevated interest rates, it's smart to have some of your investments in assets that are uncorrelated to the broader markets and can help stabilize your portfolio. And, gold can act as a safety net or portfolio insurance since it tends to hold its value or even rise when other investments are suffering. 

That's because stocks and real estate can drop in value quickly during periods of market turmoil, but gold has been valued for centuries as a crisis commodity that maintains its purchasing power through tough times. And, since gold doesn't rely on any company or government promises, there's no default or counterparty risk.

Physical gold supply constraints limit risk

A key advantage gold has over paper assets like stocks is that its supply is limited by physical constraints. While companies can just print more stock shares, mining production of new gold is limited due to fewer big discoveries and the difficulty of extracting it from the ground. The limited supply acts as a floor under gold prices since extracting each ounce of gold requires paying real mining and transportation costs. 

And, running out of minable gold puts a cap on how low prices can go. So during periods when gold demand is high, like it is in today's elevated rate environment, the scarcity of gold helps buoy gold prices and drive them higher, allowing investors to capitalize on the price gains.

Demand remains robust amid the current landscape 

Gold prices have been climbing in recent months, but demand for gold has remained very strong even with prices elevated. For starters, major central banks around the world have been buying gold as they look to diversify away from the U.S. dollar given inflation concerns. And, average investors have also been piling into gold with inflation soaring. With limited supply and steady demand drivers, that combination is likely to continue supporting gold prices, especially as high rates remain paused.

The bottom line

While higher interest rates create headwinds for many asset classes, gold stands out as an attractive investment in the current environment. Its ability to hedge inflation, perform well when rates are elevated and provide safe-haven diversification makes it an appealing portfolio addition. And, with inflation proving difficult to tame and rate cuts seemingly pushed out, now could be an opportune time for investors to gain exposure to gold.