Interest Rates And The Future Of Gold

From day to day and week to week, short-run fluctuations in the price of gold have, of late, been driven almost entirely by expectations of prospective Federal Reserve monetary policies, particularly with respect to short-term interest rates. 

In turn, these expectations have been driven by the flow of economic data and the somewhat opaque and contradictory comments by one or another Federal Reserve official. 

Here’s what’s going on: signs of an improving economy lead the gold and financial markets to expect the Fed will begin raising interest rates sooner rather than later – a negative for gold and a plus for the U.S. dollar. 

And, signs of a weaker economy lead the markets to believe the first tightening of Federal policies and initial increase in interest rates – a plus for gold and a negative for the dollar – will be postponed until the Fed sees sustainable recover down the road. 

Thus, the decline in the price of gold a few weeks ago reflected signs of an improving economy . . . and the bounce back in the price of gold in the past few trading sessions reflects more recent indicators of a weaker than heretofore expected economic growth and employment. 

Judging from the financial press, it seems that most business and government economists – including those at the Fed – anticipate healthy rates of economic growth in the next few months and, indeed, years. 

Under such a rosy scenario we would expect continuing measured increases in the Fed’s short-term policy rate.  This is the interest rate at which banks lend funds among themselves and borrow from the Fed itself – and presumably this key interest rate reverberates through the entire interest spectrum. 

Such an environment of persistently rising rates would, at least for a while, constrain gold’s inherent urge to appreciate – an urge dictated by the physical market’s seemingly insatiable appetite to acquire more gold.

But wait, that’s not the end of the story:  In my view, the U.S. economy remains anemic – and proponents of the rosy scenario are likely to be disappointed. 

As I see it, the economy will continue to underperform for a very long time to come, suffering from what some economists have labeled “secular stagnation.”  The household sector cannot fund a recovery in consumer spending because it remains overly indebted, underemployed, and emotionally depressed (or at least prone to more cautious behavior) while much needed government spending is politically impossible as long as Washington remains gridlocked. 

A number of recent economic indicators – including industrial production and manufacturing, retail sales, and housing starts – support this view . . . and economists are beginning to cut back their forecasts of economic growth for the current year.  Moreover, the U.S. economy is facing weaker export markets, and it is now suffering from the stronger dollar, which makes American exports less competitive. 

A reassessment of economic prospects and reassessment of Fed policy in the months ahead could be just the turn of events that will support a springtime recovery in the price of gold.  

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Courtesy of www.roslandcapital.com