Will She, Won’t She? Yellen…Interest Rates And Gold

Speculation on if and when the FOMC will recommend the start of US interest rate rises continues to move gold up and down.

Janet Yellen, chair of the US Federal Reserve

The volatility of the gold price around various US economic data never ceases to amaze. Positive employment figures knock the gold price down $20-30 while less positive ones have the opposite effect. Gold price rises and falls all seem to be about the potential timing of an initial Fed increase rate hike, yet the likely real impact on gold of a 25 basis points rise in interest rates, which is all that is likely to be implemented when the Janet Yellen-led Fed eventually makes the move, should in reality be a non-event. Real interest rates would remain negative, which should be positive for gold, and while an initial rate increase may be seen as the precursor for further rises ahead virtually no-one is predicting anything beyond a slow and gradual increase.

Perhaps it should be remembered that gold’s bull market commenced back in the days when interest rates were indeed real and was symptomatic of the beginnings of a huge imbalance in key global economic factors, most notably, but not solely, in the USA.  Have these global economic factors improved? No, they have got decidedly worse, but then gold is hugely higher too, which seems logical, even though it is well off its peak.

But in the scheme of things the market presumably views that the peak was too high and reached too fast, while those with the capability to move it one way or the other perhaps see that a period of lower gold prices meets their current agenda.

Back to the interest rate scenario and the Fed’s likely actions. In truth, the latest economic stats don’t really support an early interest rates rise, however small it might be. But that doesn’t mean the Fed won’t go ahead and implement one. It’s nailed its colours to the mast and the Fed’s Open Market Committee (FOMC), which is divided on if and when interest rates should start to be raised, may feel it should go ahead with at least an initial increase – possibly as early as June – if only to test the waters and see what happens as a result in the economy as a whole. Will the general stock market react badly will be the main worry? As to gold I doubt it even comes much, if at all, into the Fed’s thinking and it probably doesn’t care either. The FOMC will, at least in principle, see gold as an irrelevance and if it thinks about it at all would probably welcome gold weakness as the corollary to that could be seen as dollar strength.

As the consultants at Metals Focus pointed out in their latest Gold Focus 2015 report, gold may well benefit once the fact is in place. The report states “…we believe that the actual start of interest rate increases will paradoxically remove a major headwind for gold as an investment. This is premised on the assumption that increases will be slow and modest, leaving short-term rates in negative territory for some time to come. Given the US economy’s dependence on private consumption and high absolute levels of household debt, we believe the monetary authorities will be loath to allow the debt service ratio to increase significantly, to avoid derailing the country’s economic recovery.”

This assumption provided much of the reasoning behind Metals Focus’ suggestion that this year would see the end of the three year bear market in gold with a mild recovery once the initial Fed interest rate decision has been made, and looks for further price recovery in 2016.

This ties in pretty well with the writer’s own viewpoint. The Fed will raise interest rates sooner or later (but they will be extremely modest in order to make a point and test the water rather than in real belief that the market is ready for significantly higher rates for some time to come) and once these are in place and the market realises that they will in effect make little difference, the gold price should stabilise and perhaps begin to move up again. We shall see.

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Courtesy of http://lawrieongold.com/