The Effects of Rate Cuts on Gold and Banking Stocks
What is the Relationship between Interest Rates and Gold prices & Banking Stocks for Investors ?
This article covers the following broad questions:
What is the relationship between interest rates and gold prices?
How do interest rate cuts affect gold prices, historically?
How do interest rate cuts impact banking stocks?
What is Net interest Margin (NIM) and how does it relate to interest rates?
How do declining interest rates affect a bank’s Net Interest Margins?
What are the potential impacts of interest rate cuts on banks’ interest income and expenses?
The relationship between interest rates and gold prices is often viewed through the lens of opportunity cost. When interest rates decline, traditional fixed-income investments like bonds and savings accounts offer lower returns, prompting investors to seek alternative assets that can potentially preserve or increase their wealth.
Gold, historically regarded as a store of value, tends to benefit under such circumstances due to its perceived stability and inflation-hedging properties.
Let’s delve into historical examples to illustrate this phenomenon:
2008 Financial Crisis: During the global financial crisis, interest rates were slashed by central banks worldwide in an effort to stimulate economic activity and ease credit conditions. In response, gold prices surged as investors sought safety amid the tumultuous market environment. From 2008 to 2011, gold prices rallied from around $800 per ounce to over $1,900 per ounce, reaching record highs.
Post-Dotcom Bubble Era: Following the burst of the dotcom bubble in the early 2000s, the Federal Reserve embarked on a series of interest rate cuts to support the economy. This accommodative monetary policy environment fuelled a multi-year bull run in gold prices, with the precious metal experiencing significant appreciation.
COVID-19 Pandemic: In 2020, as the COVID-19 pandemic wreaked havoc on global economies, central banks once again slashed interest rates to historic lows to mitigate the economic fallout. Consequently, gold prices soared to new heights, surpassing $2,000 per ounce for the first time, as investors sought refuge from the uncertainty and volatility plaguing financial markets.
The impact of decreasing interest rates on banking stocks is somewhat nuanced.
While lower interest rates can compress net interest margins^^ — the difference between the interest income generated by banks and the amount of interest paid out to depositors — banks can potentially benefit from increased loan demand spurred by cheaper borrowing costs. Additionally, accommodative monetary policy measures aimed at stimulating economic growth can support overall market sentiment, which may positively impact banking stocks.
However, prolonged periods of ultra-low interest rates can pose challenges for banks, particularly those heavily reliant on interest income. Nonetheless, banks with diversified revenue streams and robust risk management practices may navigate the low-rate environment more effectively.
Moreover, a flattening yield curve resulting from declining interest rates can squeeze profitability for banks engaged in traditional lending activities.
<I have discussed Yield curve in a separate piece on Medium>
^^ What is Net Interest Margins (NIM):
Net interest margin (NIM) is like the profit a bank makes from the money it borrows and lends out.
Imagine you have some money in a bank. The bank pays you interest on that money because they’re using it to lend to other people, like for mortgages or business loans. That’s the interest income the bank makes.
Now, the bank also has to pay interest to people who deposit money in savings accounts or Fixed Deposits. That’s the interest expense they have.
Net interest margin is the difference between these two things: how much interest the bank makes from lending money minus how much it has to pay out in interest to depositors.
So, if the bank earns more interest from loans than it pays out to depositors, it has a positive net interest margin.
^^ What is the Relationship between NIM and Interest Rates:
When interest rates are lowered, it can compress a bank’s net interest margins (NIM) because the spread between the interest it earns on loans and the interest it pays on deposits may shrink.
Impact on Interest Income: When interest rates decline, banks typically lower the interest rates they charge on loans to remain competitive and stimulate borrowing. However, the interest rates on existing loans often remain fixed for a certain period. As these higher-rate loans mature or are refinanced at lower rates, the bank’s overall interest income decreases.
Effect on Interest Expenses: Lower interest rates also mean that banks pay less interest on deposits, such as savings accounts and Fixed Deposit (FDs). While this reduces the interest expenses for the bank, the decline in deposit rates may not fully offset the decrease in interest income from loans.
^^ Also see this article :
Hope this piece was useful for you 🍁
Disclosure : I am not SEBI registered advisor. The information provided here is for education purposes only. Consult your financial advisor before taking any decisions. This is neither an advice nor endorsement.
