Though not always the case, the Wall Street consensus on interest rates proved quite accurate today. The Federal Reserve, on the heels of strong economic data and inflation nearing their target 2% level, hiked its federal funds target rate by 25 basis points to a range of 0.75% to 1%. This marks just the third time in the past decade that the Fed has raised its key measure on interest rates.

Though the Federal Reserve doesn’t directly control interest rates, the repercussions of its federal funds rate increase sends a quick ripple throughout the financial sector that lifts interest rates on variable lines of credit, and it also boosts yields on interest-bearing assets, such as CDs, savings accounts, and bonds.

The importance of opportunity cost for gold and silver

Generally speaking, Fed rate hikes are great news for investors looking to earn nearly guaranteed income from safe assets. In other words, today’s rate hike is a big win for seniors who’ve continued to struggle for years with ultra-low yields on safe assets, such as Treasury bonds and bank CDs.

However, rate hikes are rarely ever good news for precious metals like gold and silver, or the mining companies that produce these metals.

Everything comes down to opportunity cost, or the act of giving up one nearly guaranteed return in one asset in the hope of generating a larger return with a different asset. Physical gold and silver rely on opportunity costs to remain low. In short, they’re counting on the yields of interest-bearing assets to remain relatively low and unattractive. If yields stay low and/or below the national rate of inflation, investors could forgo these safer income assets in favor of a potentially higher return with gold or silver, which offer no yield. If, however, the opportunity cost of making this trade-off rises (i.e., if yields keep rising), precious-metal demand by investors could fall, hurting the spot price of gold and silver.

Source: Motley Fool

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