LAWRIE WILLIAMS: Why does gold react so sharply to poss. Fed interest rate rise schedule?

First we saw precious metals prices surge after some pretty horrendous US GDP growth figures, which analysts believed would reduce the likelihood of a Fed rate increase at all this year.  Then, only a few days later, some much better than expected job creation figures have knocked the gold price back around $30 on the grounds that the more positive data could prompt the Fed to move on interest rates before the end of the year.  Some now even put a September rate increase back on the cards again.

Whether or not the Fed will raise interest rates this year should, in my personal opinion, be pretty irrelevant to the gold price anyway.  Any rate rise which may or may not happen is only likely to be a maximum of 25 basis points which will leave the US base rate, and bond rates below real inflation.  In other words a continuation of real negative yields which, if anything, should remain positive for gold.

Let’s examine, therefore, what happened to gold last time the Fed raised interest rates by 25 basis points – in early December last year.  The gold price had come down fairly sharply in expectation of the decision to raise rates and continued to trend sideways and slightly downwards afterwards for two to three weeks on the basis that the Fed was forecasting three or four further rate increases in 2016  Well that is history and just hasn’t happened.  From the beginning of this year gold has moved upwards, sharply,  and has risen 25% year to date in the US dollar.  So much for a negative impact on gold of a small rise in US interest rates!

More important for gold’s progress, or decline, surely are the basic fundamentals affecting the market?  Big purchases into the gold ETFs; sharp falls in gold flows into Asia – and into India and China in particular; the likely beginnings of a decline in global new mined gold production; China’s attempts to play a greater part in gold price setting via the Shanghai Gold Exchangeetc.  All will likely have an increasing impact and there are views that it is already beginning to smooth out some of the U.S. futures markets induced volatility.

Be this as it may, it is still apparent that the U.S. COMEX paper gold market remains the prime price driver for the gold price – hence the undue impact of Fed interest rate deliberations - although its influence may be beginning to decline.  Today, for example, it has been announced that the World Gold Council (WGC) and the London Metal Exchange (LME) are linking up, in collaboration with banks Goldman Sachs, ICBC Standard Bank, Morgan Stanley, Natixis, OSTC and SocGen,  to offer spot, daily and monthly futures, options and calendar spread contracts for gold and silver under the LME Precious banner. Future developments will include platinum and palladium contracts.  This looks like an attempt to wrest away some of the paper and physical gold business currently conducted on COMEX, thereby further reducing the impact of the U.S. markets on the global gold price, and also to stifle some of China’s ever-increasing influence. Although as far as the latter is concerned with China both the world’s biggest consumer and producer of gold this may all be too little too late.

09 Aug 2016

About the author

Lawrence Williams

Lawrence (Lawrie) Williams is a well known London-based writer and commentator on financial and political subjects, but specialising in precious metals news and commentary. He is a qualified and experienced mining engineer having graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London - recently described as the World’s No. 2 University (after MIT).

e: lawrie.williams@sharpspixley.com