LAWRIE WILLIAMS: Asset recovery under way, but does it have legs?
As seems to be usual practice of late, asset prices all seem to have made recoveries after the sharp downturns realised which immediately followed last week’s FOMC meeting. To be frank we are not surprised to see the precious metal price movement back upwards, but had not expected equities and bitcoin to do so. In our view the U.S. Federal Reserve (the Fed)’s distinctly apparently more aggressive approach to interest rate rises this year, and presumably into future years, should have been hugely negative for equities, if perhaps not so much so for gold and silver. Bitcoin tends to plough its own course however, dependent upon which supposed expert commentator’s analysis the investor believes most.
What the Fed appears to have decided is that its mission to bring employment recovery up to the maximum achievable rate has already been successful, and it can now turn its firepower on inflation, which it now admits is rising faster, and likely to persist for longer, than it had previously recognised. As usual, the remedy for this is to increase interest rates, and keep on raising them, until businesses are squeezed sufficiently to stop inflationary tendencies in their tracks.
Associated equities have become used to Fed largesse in the form of bond and mortgage security accumulation, coupled with ultra low interest rates, driving up stock prices to record levels. The security buying programme is due to end next month and it is now anticipated that the Federal Funds base rate, which filters through to all other interest rates, will start to be increased immediately thereafter. Prior to the latest FOMC meeting it had been expected that there would be three or possibly four 25 basis point interest rate rises this year. Following the meeting, Fed Chair Jerome Powell’s press conference was interpreted as suggesting there might be five or six rate increases this year, and/or some of these might be of 50 basis points instead of the usual 25. This substantially more aggressive approach by the Fed led to a sharp downturn in equities around the world as one would normally expect..
The prospect of less money filtering through to the equities market, and higher interest rates, would normally depress stock prices, and so it seemed to do, at least initially. But the associated fall was quickly reversed with equities seemingly beginning to make a respectable recovery at the end of last week, and filtering through to the current week too. A continuing fall in stock prices might be seen as signs of a recession ahead, but with this beginning to fall out of the equation, confidence seems to be returning to the markets which will be music to the Fed’s ears as long as it persists and may convince it to adhere to the more aggressive approach to its proposed interest rate raising programme. An equity slump might have seen the Fed backtrack, at least in part, on the more aggressive interest rate raising scenario,
As for gold and silver, while history shows they may be affected adversely by rising interest rates, this is because other assets start to look to be better buys than an asset which does not generate returns. However, this is only true when real interest rates are positive. In the current high inflation environment, the Fed will be unable to raise interest rates sufficiently for real rates to enter positive territory for some months, if not years, depending on how long it takes to bring the inflation rate down to more manageable levels. Until this happens, gold – and silver too – remain the better investments in that they tend to maintain their value whereas other assets are degraded by continuing inflation.
Currently U.S. inflation, as measured by the Consumer Price Index (CPI) is running at around 7%, and appears to be still rising. Even if the Fed increases its Federal Fund rate by 1.5% or more this year, which is at the top end of expectations, it will still mean real interest rates remain heavily in negative territory. That will thus continue to be strongly gold and silver positive. Furthermore, should equities follow the path we think they still may, which would be downwards again once the realisation sinks in of the adverse effects of the end of Fed tapering and rising interest rates, that would give another indication that precious metals are the safer investment for the time being.