LAWRIE WILLIAMS: Fed policy unchanged but gold still plunges. Markets over-reacting?
Well we were correct in assuming that, at this week’s FOMC meeting, the U.S. Fed would keep its ultra-low interest rate plus significant QE policy unchanged. However we were way out on the resultant market reaction to Fed chair Powell’s subsequent statement. In effect the Fed remained virtually unmoved on its interest rate and QE policies, but because the FOMC participants seemed to be suggesting that it would need to taper by 2023 – two years hence – the markets saw this as ‘hawkish’ and the dollar index was driven higher and gold fell back sharply to just above the $1,800 mark – a level last seen back in February when gold was going through another weak phase. Gold fell again in European trade today and the $1,800 level looks like being comfortably breached again on the downside – indeed it has been as we write with the gold price down to the $1,770s.
Two years is virtually an eternity in global economics, so the judgement on something that may not happen until then, seems incongruous to say the least. But then I’m a mere mining engineer, and thus a pragmatist, and find such reaction a little ludicrous.
As we have stated before, though, markets often – indeed usually - tend to over-react and this looks to be very much a case in point and now may well prove to be a great buying opportunity for the gold investor. At one time today, gold had fallen over 2%, silver over 4%, platinum off 5%, and palladium and rhodium around 10% - all from previously depressed levels. That is despite nothing having actually changed in the short term for the Fed’s low interest rate policy and with the parallel conclusion that inflation will likely exceed the Fed’s target rate, albeit probably temporarily as the current post-pandemic catch-up phase fades away. This combination of near zero interest rates plus higher inflation should, in reality, be hugely positive for the gold price going forward and for other precious metals too.
But reality and the markets do not always move in concert, as we have been noting with what we see as unsustainable equity market growth almost ever since the pandemic started to impact the economy. The huge valuation of bitcoin, which to us is crazy, looks to be another case in point. True, bitcoin at one point in recent weeks lost around half its inherent value, but is still grossly overvalued in our view and if social media starts to move against it, it could easily fall by a similar amount again, although we see this as unlikely.
So what happens to precious metals next? If markets follow logic, gold should claw its way back up to the $1,900 level – possibly within the next few weeks – and then move higher as the year progresses. We still see gold reaching $2,000 again this year, despite this latest setback – but again we don’t see $5,000 or $10,000 gold as being likely in the foreseeable future as some of the perma-bull optimists would have us believe. Even if the Fed is bounced into increasing interest rates to combat rising inflation sooner than it continues to aver, any such increases are likely to be tiny, which will still leave us with effectively negative real interest rates, further enhanced by the rising inflation rate. Negative real interest rates are seen as positive for the gold price as it remains perhaps the best of all wealth protectors in this kind of financial environment.
We may get a little more clarity on likely U.S. and global policy at the annual Jackson Hole jamboree in late August, if not before. The Fed’s prestigious annual policy symposium comprises a yearly get-together of the world’s top central bankers and economists and will be back at its usual location in the Grand Teton National Park outside Jackson, Wyoming from Aug. 26-28.
Inflation, and possible attempts to control it, is likely to be the real key to precious metals’ future performance in the year or so ahead. There is little doubt that it is currently running higher than generally anticipated throughout the globe. Latest U.S. Consumer Price Index data puts it at worryingly close to 5%. Dire warnings of hyper-inflation seem to be typical scaremongering tactics from some of the financial elite, but the U.S. Fed still seems to be following the path it has been doing for some months now and is still preaching caution on interest rates as it believes the higher inflation currently being seen is likely to be transitory (the current buzz word) and down purely to businesses trying to make up for their losses during the pandemic lock downs, and thus likely a temporary phenomenon.
The worries for gold and precious metals is that if the Fed feels the need to raise U.S. interest rates, that will boost the dollar index, provided other central banks don’t follow suit, and a higher dollar index is usually reflected in a weaker gold price in dollar terms. However we would re-emphasise that if the Fed was to raise rates it would be only by a tiny amount, and if this were to happen it would only do so because of .high inflation and thus would leave real interest rates in effectively negative territory. And gold and the other precious metals tend to thrive in this kind of environment.