Gold Is a Safe Bet No Matter What the Fed Will Do
Gold prices have dropped from $1,340 an ounce in September to as low as $1,250 late last week. This is largely due to forecasts of a rate hike by the US Federal Reserve. But the sharp drop in gold began to reverse on Monday. The price rose by more than $25 in just three trading days.
Most gold analysts say the main reason for the bounce is reaction to comments made by Yellen last Friday. Judging from what Fed Chair Janet Yellen said last week, gold is likely to move up no matter what the US economy does.
Fed Chair Yellen highlights plans for “high-pressure economy”
In a speech in Boston, the Fed Chair suggested the best way to kick-start the US economy may be to let the economy operate at “high pressure” for a while.
Yellen hinted she would allow the inflation rate to rise above 2%. She did not use the word “inflation,” but her remarks hint that a higher inflation rate might be tolerated or even encouraged. In other words, she would not hike interest rates to slow down the economy.
Yellen thinks the damage done to the economy by the financial crisis and recession can be fixed with robust aggregate demand and a tight labor market.”
This surprised analysts and the markets.
Yellen pointed to negative interest rates as another tool if economy slows
The recent consensus was that the Fed will wait until after the election in November to boost rates. However, it now seems there will be no rate hike before the end of the year. That is, unless economic data improves greatly in the short term.
Of course, there is a very real possibility the US economy will not continue to move forward. It may even slip back into a recession. The risks are both economic and geopolitical.
Political tensions surrounding Russia, Syria, and Ukraine are increasing. And Europe is in social crisis. They are trying to deal with a huge wave of immigration. Also, the European banking system is creaking under various strains.
Yellen is already on record as saying that negative interest rates are just “another tool in the arsenal.”
To say that negative rates are just another tool is not quite true. With very low interest rates, macroeconomics is basically the same game with a few different rules. Negative interest rates, however, are a whole new ball game.
Consequences of negative interest rates
Negative interest rates mean you are paying someone else to hold your money. This simply does not make economic sense. No economy can function for long in such a circumstance.
Negative interest rates on government and blue chip corporate debt have been the norm in Europe for some time now. This has led to a flight to US Treasuries that offer at least a small yield. All of this money flow, however, is driving down US Treasury yields, pushing them ever closer to zero.
So what will happen if US interest rates also go negative? Where will investors across the globe go in search of yield?
The obvious answer is physical assets. That’s because physical assets like gold, silver, collectibles, and real estate have the potential for price increase rather than getting eaten away over time.
Fed policy likely to boost gold prices
We are in a unique situation today in that any action from the Fed is likely to boost gold prices. Yellen’s comments Friday about running a “high-pressure economy” make it clear that inflation moving a point or two above the 2% target will not trigger a rate hike.
The Fed Chair also made it clear in remarks a month or two ago that she was not afraid to use negative rates.
Inflation is definitely a plus for gold prices. Gold has long been a popular inflation hedge. The price of gold has tracked the CPI (consumer price index) pretty closely since the 1970s, except for the last decade or so.
Source: Pragmatic Capitalism
Negative rates in the US are likely to lead to an asset boom—a gold rush as it were. As mentioned, investors would rather move into physical assets that may appreciate than watch their money gradually disappear.
Of course, if the economy starts to show strong growth, the Fed will begin a series of rate hikes to put the brakes on inflation and speculative bubbles. If they do that, gold prices will drop. This rosy scenario, however, is difficult to project based on current economic data and trends.
The more likely scenario is that growth will be enough that the Fed pulls the trigger on one or maybe two quarter-point hikes during the next year. Then the longest economic recovery in history might finally roll over into a recession. That would push interest rates to zero or below.
It’s also possible the economy continues to limp along in ultra-low growth mode. In that case, we might see no hike rates at all in 2017.
In either of the latter scenarios, the odds are good that the Fed would eventually follow the European Central Bank and Bank of Japan into negative rates.
The odds of a near-term rate hike are slim, and we might actually get negative rates in the US. So, it’s hard to go wrong with an investment in gold today. Moreover, Yellen is now hinting she will let inflation rise above the usual 2%. So, even if the economy does pick up a bit in the near term, there’s no reason to be in a hurry to hit the sell button on gold.
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