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LAWRIE WILLIAMS: Gold loses almost all its Ukraine gains as FOMC only raises rates marginally

Yet again, precious metals and general equities price movements have been largely dependent on what was decided regarding U.S. interest rates at this week’s Federal Open Market Committee (FOMC) meeting which took place on Tuesday and Wednesday.  It was a given that the Fed would implement a rise in the Federal Funds rate, but quite how big the rate rise would be remained uncertain in the light of continuing high inflation, likely to be further exacerbated by the imposition of economic sanctions on Russia.  The high, and seemingly rising, level was confirmed by the Producer Price Index (PPI) release which came in earlier this week with a double digit annual rise to 10%.  

The Fed statement went on to predict a series of small rate increases at the six remaining FOMC meetings this year culminating in an overall annual rate rise of around 1.9%  Certainly no Volcker-like solution.  The Fed sees U.S. inflation turning lower in the second half of the year to below 5%, but it should be remembered that it was predicting that inflation would be only  ‘transitory’ right up to last November, and it certainly has been far from so.  Indeed it has been accelerating and almost certainly will continue to worsen before it even begins to get better.  The Fed’s predictions of economic trends has been abysmal and there are plenty of fears that this exceedingly poor track record will be continuing.

Consensus was that only a minimal 25 basis point rise would be implemented, and this was indeed the case in the FOMC meeting statement and subsequent press release.  This will also have provided some welcome relief for equities which rosed quite sharply,  although not, as it worked out, for gold – at least not initially with the metal price dipping down to even test the $1,900 level on the downside before making something of a recovery in subsequent trade,

The latest Consumer Price Index (CPI) figure to be released, just over a week ago, had seen an annual inflation rise of 7.9%, but this data will have been calculated before the Russian invasion of Ukraine commenced and economic sanctions on Russia imposed.  With Russia being such a large global supplier of some key metal commodities, as well as grain, fertilizers and oil and gas, prospects of supply interruptions due to sanctions implementation has already been having a huge knock-on effect on prices, which is only likely to get worse. 

Russia has been hugely successful in becoming the dominant supplier to the West for many key strategic commodities – perhaps most notably for oil and gas to much of mainland Europe. The U.S.used to maintain huge strategic stockpiles of critical metals and minerals, but this policy is no more having been run down over the past decades and potential rival powers like Russia and China may now be taking full advantage.

The West will be regretting these strategic issues, about which some observers, military planners and politicians have been warning for many years, but to no avail.  The corresponding U.S. domestic shortfall of some critical metals for its defence industries in particular is also affected by China’s dominance of supply to the West of many other vital metals and minerals.  This will, no doubt, prompt a search for alternate replacement supplies, but this cannot be achieved quickly and will lead to some huge price spikes in the meantime.

Reliance on potential adversaries for critical supplies cannot be a sensible strategic policy.  In this day and age, economy and profitability appear to have trumped some obvious, in hindsight, many such key issues.  These could seriously affect America’s short to medium term plans to respond to any future military threats.  In the NATO context, any ongoing lack of fuel could be a serious logistical issue should Russia decide to invade a NATO member state, although it may be increasingly reluctant to do so given the lack of rapid success of its supposedly far better-armed and numerically-superior force invading Ukraine.  Victory against a better-equipped military force is certainly no foregone conclusion.

As for gold, the price seems likely to regain some of its previously elevated levels not only due to the geopolitical uncertainties in Europe, but also to the impact of inflation which looks as though it will get worse before it begins to get better.  The minimal interest rate rise coming out of the FOMC meeting will have allayed some temporary economic fears in the U.S., and in a knock-on effect around the rest of the world, but high, and likely rising, inflation data may well put a stop to any resultant complacency for equities markets about what may lie ahead in attempts to bring the inflation beast under control.

As we have stated beforehand, the relatively cautious approach by the U.S. Fed, and by other central banks which tend to follow the U.S. lead, will almost certainly leave real interest rates distinctly negative for months, if not years, to come.  Negative real interest rates tend to be positive for non interest-generating assets like gold, which should start to regain some of its lost ground once markets settle down again. 

However, if real progress appears to be being made in a cessation of hostilities in Ukraine and some of the geopolitical uncertainty is reduced, then this could provide some gold price headwinds.  Even so, we still feel that the gold price will end the year around, or above, the $2,000 an ounce level.

17 Mar 2022 | Categories: Gold, China, Russia, US, FOMC

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