Where Next For Gold With Fed Rate Decision Finally Done?

So the Fed stopped playing with the market and finally increased rates by 0.25 per cent on December 16th. This had become the consensus view and came as no shock, so nothing much happened in financial markets, at least at the moment of long-delayed action.

Gold took the knock on the chin and reeled down about $10 before getting up off the floor. Where the price of the yellow metal goes next is a tough call but there seem to be two main scenarios doing the rounds right now.

Goldman Sachs

First, there is an extension of the Goldman Sachs’ theory that the dollar will continue to strengthen and gold weaken as interest rates gradually clock higher and higher. The problem here is that Goldman holds a terrible record on gold price predictions over the years, and the long-dollar trade is the most crowded in the world.

Whoever made money following the wisdom of crowds? I suppose it has not worked so badly in US stocks for the past seven years. But then you have to ask whether the law of gravity has actually been suspended and what has gone up can only ever go up. 

Parabolic curves also always end in disaster in markets, almost always after final spike. You could argue that this final spike is still to come for the US dollar but if so it shouild not be far off. 

Secondly, there is the US stock market at a tipping point view. David Stockman wraps this up nicely as the Fed’s rate rise being a pin that bursts the stock market bubble. In this scenario precious metals are likely sold off with stocks in a rush for margin calls as happened in 2008-9. 

Elliott-Wave

Elliott Wave theorists also like this scenario as it would put in what many of them see as the fifth and final wave of the gold bear market. Followers of Avi Gilbert’s lively discussions will know that this kind of mini ‘flash-crash’ for gold would set the scene for a 2009-11 style rally in the gold price - which trebled from its low to knock on the door of $2,000 an ounce by April 2011.

I suppose there is a good reason why so many long-term asset holders - such as the global central banks - like to hold gold and often no not trade it over many decades.  It’s an insurance policy. Nothing holds its value like gold over the long-term. Companies come and go. Bonds all reach maturity or default. The paper US dollar has been losing value ever since it was first printed. Gold from an Egyptian tomb still does the business.

But in the short-term this is not really the point. If you say tomorrow, ‘Heck I’ve had it with gold. I lost money this year and last and the year before. If it goes down then again then I will buy it back as I know all these things go in cycles’.

Yet will you really do it. Probably not. You won’t get back in until you can see that gold is really on the way back and by then you will have missed out on the upturn, and you will have crystalized and taken that loss by your gold sale. The Irish call it ‘sod’s law’. 

Gold prices going up

Perhaps it is best to be a contrarian anyway. Buying low and selling high is a very easy and proven route to riches and yet so many people do the opposite, like selling gold now and buying back later at higher prices. If you can’t get this much right then you should not be investing. 

And of course you should not be investing at the moment in conventional asset classes. How can the higher interest rates that the Federal Reserve has just promised us possibly be good for the prices of stocks, bonds or real estate? All of them now have to adjust downwards in value to reflect the higher cost of money to buy them. 

Where will the money flow next? George Soros was much misunderstood a few years back when he said that gold would be the ‘ultimate bubble’. What he meant was that in the investment cycle a bubble in the gold price is always the last bubble in a sequence. 

If you go back to the days of the South Sea Bubble and John Law it was the insiders selling their shares and buying cartloads of gold to shift overseas that marked the end of this particular investment mania. What we have seen in almost a decade of super-low interest rates in terms of speculation in paper makes the South Sea Bubble look a picnic in the park. 

Where does money go when the conventional global financial system comes badly unstuck? Well we saw in 2009-2011 that the reflex reaction of buying gold and silver was still very much in place. Gold and silver recovered and boomed in price while other asset prices were still on the floor or close to it. 

Deja-vu all over again?

If what we are about to see is a bigger and more spectacular bubble going bust then expect the same behavior, at first by the few and then by the crowd. When gold and silver become a crowded trade, say in mid-2017 then it will be time to sell up and buy depressed conventional assets again. 

And what is the most likely thing to prick an asset price bubble? Surely a rise in the cost of funding the bubble which is what we have just seen this week with the Federal Reserve raising its key interest rate. How long this will take to have an impact is impossible to tell but we are not talking about a very long period. 

The far less probable event is that raising US interest rates into a slowing global economy will be a successful strategy for promoting US economic growth and interest-rate sensitive asset prices. The contrarians have this right and gold and silver are the way to go.