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Gold Rises on the Latest Fed Rate Increase

By Gary Alexander March 15, 2017

 

Just as we indicated here on March 3, and in previous Navellier Gold updates, gold has recently tended to FALL in advance of a Federal Reserve rate increase and then RISE after the Federal Reserve actually raises rates.  Sure enough, after dipping below $1,200 on Tuesday, March 14, gold shot back up to $1,220 shortly after the Federal Open Market Committee (FOMC) raised rates 0.25% at 2:00 pm Eastern time on March 15.  This has happened twice before – after each previous rate increase in 2015 and 2016 – and over the course of the Federal Reserve’s previous rate-rising cycle (raising rates 17 times, 2004 to 2006).

Counting backward….

  • The last time the Fed raised rates was on Wednesday, December 14, 2016.  The London close for the gold price the next day was $1,127.  We saw a slightly lower low the following week with a dip to $1,125.70 on December 20, an 11-month low.  Gold then rose to $1,257.20 in the next two months, rising 11.7% before making a correction the week before the March 15 rate increase.
  • The previous December, the same basic result happened.  The Fed raised rates for the first time in nine years on Wednesday, December 16, 2015.  The London setting the next day was $1,049.40, which turned out to be gold’s lowest close of the last eight years.  Gold rose nearly $30 the next two trading days and reached a 2016 high of $1,366 on July 6 – up 35% in barely six months.

In both of these recent cases, we can see that gold declined for about a day after the rate increase before bottoming out and eventually rising.  Maybe this week’s alert traders knew that history and jumped the gun, investing immediately after the rate increase was announced on March 15.

  • Going back further, the Federal Reserve raised rates by 0.25% in each of 17 consecutive meetings of the FOMC from mid-2004 to mid-2006.  During those two years, gold rose from $395.80 on June 30, 2004 to $613.50 on June 30, 2016, a 55% gain during a time when the fed funds rate rose from a miniscule 1.0% to a peak of 5.25%.  Both gold and stocks shrugged off these actions.

Despite these clear facts from recent history, you still hear the general statement by pundits (who are supposed to know their craft) that “gold tends to decline after interest rate increases since it offers no interest income.”  That might sound logical on the surface, but in the real world, the safest and most established currencies in the world offer VERY LITTLE income (near-1% in the U.S. and near-zero in Europe and Japan), so the income difference is really trivial.  Besides that, currencies trade against each other in a zero-sum game, whereas gold has huge capital gains potential, if held over the long-term.

Let me give you a personal example….

50 Years Ago, My Gold Class Ring Cost Under $50

I just returned from my 50th college class reunion.  Since we were a small college, it was a multi-year, multi-campus affair.  A few of us wore our gold class rings.  At the time (1967) forking over $45 to pay for a ring containing about one Troy ounce of gold seemed like a frivolous expense.  We didn’t make much money and $45 was a fortune.  Little did we know at the time, that ring was one of the few legal ways to buy gold at the fixed price of $35 per ounce.  Gold ownership in bullion, bar or coins was still forbidden after FDR’s gold recall in 1934.  Americans weren’t free to own most forms of gold until 1975.

At our Tuesday night banquet this week, I recounted some of our college expenses for my classmates.  Young people may be stunned to hear that we paid $16 per unit (semester hour) for college tuition (under $500 per year), $90 per month for room and board, less than $10 for new textbooks in perfect condition, and a $40 gold class ring. Being a musical fellow, I put it into song (to the tune of “My Favorite Things”)

Sixteen a unit for college tuition
Ten bucks for textbooks in perfect condition
Forty-five bucks for a golden class ring.
These were a few of My Favorite Things

As I recall, our golden class ring contained one Troy ounce of gold and a little under one ounce of alloys, since 14-karat gold is 58.3% gold and 41.7% alloys.  The college underwrote charges over cost, so we got the ring for $45.  The melt value (which I would never do!) is now $1,220, a 27-fold increase in 50 years.

On the other side of the trade, minimum wage throughout my college years was only $1.25 per hour, but somehow the janitorial department managed to get away with paying me $1.10 an hour, so $40 was a big deal (40 hours, after taxes).  However, at the end of four years, my college debt was only $550.  Compare that with today’s astronomical college debt load. The inflation genie was certainly let loose after 1967.

What set that inflation genie loose?  In 1965, President Lyndon Baines Johnson took the silver out of our coins, and three years later, he began devaluing gold.  On March 20, 1968, President Johnson signed a bill removing gold backing from the dollar.  This was the first step toward full abandonment of gold in 1971.

Looking at the long-term, since my graduation, gold is up 27-fold and stocks are up about the same.  In the middle of March. 1967, the S&P 500 traded around 90. Today it is around 2385, for nearly a 27-fold increase.  Stocks also offer dividends, so the total return in stocks still beats gold over the last 50 years.

But what gold offers is portfolio balance.  In the 1970s stocks collapsed in real terms, while gold soared.  The same thing happened from 2000 to 2009 – stocks tanked twice while gold soared.  In between, from 1980 to 2000 and since 2011, stocks have clearly beaten gold, but it’s better to own both rather than one.

This chart, from Mining.com, shows how far out of balance the gold vs. stock trade-off can get.  At one point in early 1980, the Dow was around 850 and gold was $850 per ounce – parity!  Then, like Rip van Winkle, you awake 20 years later (January, 2000) and gold is $283 while the Dow is 11,725 – a ratio of more than 40-to-one.  In hindsight, it was smart to buy gold and sell stocks in 1968.  Then, it was smart to sell gold and buy stocks in 1980, then to sell stocks and buy gold in 2000.  But where do we stand now?

Table 1

Chart source: Mining.com, data through December 2013

Using the broader S&P 500 rather than the Dow Jones index, the average value of gold in the 50 years from 1964 to the end of 2013 was 1.13 times the S&P 500.  That ratio dipped to 0.7154 in 2013, which seemed like a great buying opportunity at the time, but gold still had lower to go, since markets tend to go to extremes.  The current ratio of gold at $1,220 to the S&P 500 at 2,385 is barely 50% – at 0.5115.

That means that gold is still a relative value to stocks and this would be the time to load up on more gold.

The Dollar is Down 98.3% in the Last Century and 97.1% since 1967

 

At Navellier Gold, we feel it is a mistake to compare gold to the stock market.  Both are excellent over time. There is no need to create an artificial war between Wall Street and “gold bugs.”  Gold should be compared to currency returns, not stock returns.  The dollar is strong today – it has been rising ever since 2011 and dramatically since mid-2014, but over the longer-term, the dollar has declined sharply to gold.

Gold was fixed at $20.67 when the Federal Reserve was born.  That fixed price lasted until 1934, when President Franklin D. Roosevelt raised the price to $35, by fiat.  With gold’s price now around $1,220, the dollar has lost 98.3% of its value in a century.  Today’s dollar is worth what 1.7-cents could buy in 1913.

Over our lifetimes, the erosion of the dollar to gold is equally dramatic. The 1967 dollar was worth 1/35th an ounce of gold.  Today’s dollar is worth 1/1220th ounce of gold, or a 97.1% decline in the U.S. dollar.

Adjusted for inflation, using a constant-value dollar (set in May 2016 dollar terms), the peak price of gold was $2,478 in January 1980.   Its peak price in 2011, in the recent bull market was only $1,895, so we have yet to approach gold’s all-time high in inflation-adjusted terms. Still, gold has gained ground five times faster than inflation in the last 50 years, from $250 (inflation-adjusted, $35 nominal) to $1,220.

Table 2

Source: Inflationdata.com; data current through June 16, 2016

Personally, I couldn’t afford to buy stocks in the 1970s – which was a blessing in disguise, since stocks kept going down in real terms during that decade – but I had that college ring and few other gold and silver coins to tide me through until the inflation of the 1970s and await the time when the stock market began rewarding investors in a real way starting in 1982, when gold entered into its 20-year slumber.

The lesson for today’s investors is the same as for those investors graduating from college 50 years ago:  Seek a balance in stocks, bonds and real assets (like gold) for maximum portfolio potential over time.