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The Federal Reserve – the Gift that Keeps on Giving!
Last December 16, when the Federal Reserve raised rates for the first time in seven years, gold fell to $1049 the next day. The following week, we published this headline in our Navellier Gold update:
The Fed’s Rate Increase Sends the Dollar Up and Gold Down: An Irrational Knee-Jerk Reaction Creates a Unique Buying Opportunity
–Navellier Gold headline, December 23, 2015
We were right, then and we will probably be right again, since the Fed has given investors yet another golden buying opportunity. So far in 2016, stock markets are flat and gold is up 18% (as of last Friday). But whenever the Federal reserve “hints” that they might consider raising rates, gold usually goes down.
This kind of knee-jerk reaction is irrational – as we will show below – but it is predictable and therefore a good way to time entries into the gold market for maximum future capital gains. Here’s what happened last week, and why it opens the door for gold investors to add to their position or open a new position.
Last Wednesday, May 18, the minutes of the April meeting of the Federal Open Market Committee (FOMC) were published. The notes generally come out around 2:00 eastern time. Going into the top of the hour, gold traded at $1273, but after the release of the minutes – in which the FOMC hinted that a June 0.25% rate hike was possible – gold traded down to $1263 in minutes, then to $1256 by the close of the day and then down to $1244 the next morning, closing the week at $1252, for a net $21 two-day loss.
Once investors come to their senses – usually a slow process – gold should recover since (1) the Fed will likely not raise rates in June, or any time before the coming elections, and (2) gold has historically risen during previous times of rate increases, including the massive bull markets of 1976-1980 and 2001-2011.
(1) Why the Fed will not Likely Raise Rates until December (if then)
“Members generally judged it appropriate to leave their policy options open and maintain the flexibility to make this decision based on how the incoming data and developments shaped their outlook for the labor market and inflation, as well as their evolving assessments of the balance of risks around that outlook.”
–Minutes from the Fed’s April 26-27 FOMC meeting, released last week
Most Federal Reserve Board governors and FOMC voting members often remind us that the Fed is “data-dependent,” meaning that they will watch all economic indicators released before June 15. We should do the same thing in order to make an intelligent guess about what the Fed will due come June 15 or July 27.
Here’s what we know about the current U.S. economy from the most recent major economic indicators:
GDP growth is anemic, up 0.5% in the first quarter and likely up 2% or less for the full year. Last week (in its Global Credit Research report, released May 18), Moody’s Investor Service cut its estimate for 2016 GDP growth to 2%, down from its previous estimate of 2.3%. Moody’s cited subdued global demand and weak business investment as their main concerns lowering their GDP growth estimate.
Inflation-adjusted hourly wages declined -0.1% in April and have only risen 1.3% in the past 12 months. Fed Chair Janet Yellen’s background is as a labor economist and she has made it clear that the FOMC wants to see real wages rise before hiking rates further. April non-farm payrolls came in well below consensus. Although the jobless rate is only 5%, many new jobs are low-paying or temporary jobs.
S&P 500 first-quarter sales and earnings were negative for the fifth quarter in a row. Most analysts expect a sixth straight negative quarter when second quarter earnings are released in late July and August. The Dow and S&P 500 are up just 0.4% for the year-to-date as of last Friday. The Fed watches the stock market’s mood when making a decision, so a flat market performance is not conducive to a rate increase.
The yield curve is narrowing sharply, signaling a slowing economy or a possible recession. When long rates (10-years duration or above) are shrinking while short-term rates are rising, the yield curve narrows. The most widely-watched indicator for the yield curve is the difference between the 2-year and 10-year U.S. Treasury yields. In late 2013, the spread was 2.65% (265 basis points). The difference last week dropped to just 94 basis points, the narrowest spread since late 2007, right before the last recession.
In addition to these economic concerns, there are two vitally important political concerns coming up:
Britain will vote to leave (or stay in) the European Union on June 23. Current polls say the vote is too close to call, but if Britain votes to exit the E.U. (a “Brexit”), the British pound and euro could decline to the U.S. dollar. If the Fed raises rates the previous week, this would make the dollar stronger, potentially causing a panic in currency markets, perhaps causing the Fed to reverse its rate increase in July or later.
This U.S. election is one of the most contentious in history. The Fed will not likely want to raise rates on the eve of the Presidential nominating conventions, or during the run-up to the November election. This makes December the most likely month for an interest rate increase (if any) for the year 2016 as a whole.
From this economic data and political background, we feel it is likely that the Fed will not raise rate until December, if then. If the Fed raises rates before then, gold will likely drop for a while, but that would only make for another great buying opportunity. Long-term, a rate-rising cycle is not an impediment to owning gold for portfolio balance. By contrast, gold’s biggest bull markets came in a rate-rising cycle.
(2) Historically, Gold has Usually Risen as Rates Rise
“Between January 1970 and January 1980, gold skyrocketed 2332% higher! Over that exact span the benchmark federal-funds interest rate the Fed targets averaged 7.1%…. Then between April 2001 and August 2011, gold soared 640% higher… the Fed funds rate still averaged 2.1% during that span.”– Adam Hamilton, Zeal Research
The conventional wisdom is wrong. The mainstream media suffer from a gigantic blind spot when it comes to gold. They assume that gold will go down if interest rates rise, since “gold offers no interest income,” so rising interest rates will take investors away from gold and toward cash deposits.
One big problem with that theory is that 0.50% to 0.75% (which would be the range of the Fed funds rate if they raise it in June) is hardly “high” interest. Europe and Japan offer negative interest rates, while the U.S. dollar, even with a rate rise, still offers some of its lowest returns of the last century – below 1%.
A second big problem with this theory is that it does not jibe with monetary history. The mother of all rate-cycle increases came in the late 1970s, when the Prime Rate hit 21% and gold soared from under $300 to over $800 in barely six months – from July of 1979 to January of 1980. Since then, here’s how gold jas fared during the start of the last four rate-rising cycles – from 1986, 1994, 1999 and 2004:
The last time the Fed raised rates in a “cycle” (i.e., several small increases of 0.25% each), the Fed made 17 straight rate increases from 1% in June 2004 to 5.25% in June of 2006. During those two years of incessant interest rate increases, gold rose from $385 per ounce in June of 2004 to $625 in June of 2006.
Even though gold doesn’t offer interest, you could also say that of most stocks don’t pay dividends, and neither does real estate. Some of the biggest stocks offer no dividends – like Facebook, Amazon, Netflix or Google/Alphabet. Over the last seven years, cash in the bank has offered near-zero interest, and a small rise to 0.5% or even 1.0% is irrelevant when compared with gold’s long-term arc of capital appreciation.
The Fed has given us another gift – another gold price correction – so now is the time to buy more gold.