Fed Chatter Dumps Cold Water on The Price of Gold and Silver
Since the beginning of the year gold had been on a tear. Gold has risen over 20% making it gold’s best start to a year in decades and the best performing asset class in the world. Silver has also risen about 15% since January.
Since January, record amounts of funds have flowed into gold ETFs. In early March when fund flow was at its peak one gold ETF, Blackrocks’ iShares Gold Trust (IAU) suspended issuing new shares supposedly due to an “administrative oversight”. Silver ETFs also saw a marked increase in fund flows in the first quarter of 2016.
Negative Interest Rates
One factor driving the price of gold higher was the preponderance of negative interest rates in Europe and Japan and background chatter from Fed officials and Former Fed Chairman Ben Bernanke that negative interest rates might be considered in the United States.
Negative interest rates mean holding cash is a losing proposition. One knock against investing in gold is that it doesn’t pay interest. With cash deposits losing value due to negative interest rates, gold not paying interest, in comparison, doesn’t seem such a bad proposition.
Stagnant Global Economy Means More Central Bank Stimulus
Besides negative interest rates, central banks around the world from the European Central Bank, the Bank of Japan and the Bank of England are engaging in quantitative easing (QE) programs whereby they inject liquidity into markets by purchasing sovereign and corporate debt and even selected equities to combat stagnant economies. Central banks printing their currencies out of thin air, has had the impact of debasing the issuers’ currencies and driving them down vs. the price of gold and the dollar. Since the United States Federal Reserve ended its QE program at the end of 2014 and has nominally begun to raise interest rates, the dollar rose vs. foreign currencies and gold all through 2015.
Stock Market Sell Off
January 2016 was the worst US stock market annual start ever! With declining equity prices, gold seemed an attractive safe haven from the stock market carnage. In March, equity prices rebounded and have erased the losses incurred earlier in 2016. For a while the stock market and gold and silver rose together. Recently, the prices of gold and silver have stalled.
What the Fed Giveth, The Fed Taketh Away
In light of the foregoing market dynamics, the Fed decided to hold off on interest rate hikes in the first quarter of 2016 which also aided the gold price. Higher interest rates in general are bad for the price of gold especially if they are higher than the inflation rate. At the Federal Open Market Committee Meeting earlier this month, the Fed held rates at 0.25% and announced that they foresaw just two interest rate hikes in 2016, vs. the probable four they had projected earlier in the year. This dovish outlook for rate hike helped push gold and silver higher.
This week no less than six Fed officials, including the Philadelphia, Chicago, Richmond, Atlanta, San Francisco and St. Louis Federal Reserve Bank Presidents intimated that they believe a rate hike is possible in April. There are 12 regional Federal Reserve Banks. Most Fed observers interpreted the Fed’s projected two rate hikes in 2016 as occurring later in the year, not as soon as the next meeting in April. Gold and silver fell in reaction to the Fed Presidents’ pronouncements.
Fed officials hinting about a potential rate hike in April this week have referenced recent increases in the core U.S. consumer price index (excluding food and energy) and the likelihood that U.S. price increases would meet the Fed’s 2% inflation target. The low price of oil has masked consumer price inflation. When oil is stripped from the equation, inflation has been running at 0.3% a month for the past two months. Oil has bounced off its lows of 2016 during March rising from under thirty dollars a barrel to over forty dollars adding to overall consumer price pressures. A Fed that gets ahead of the inflation curve is bad for gold. A Fed, however, that allows inflation to rise higher than interest rates is good for gold.
Questions for the market:
Will the core U.S. consumer price inflation continue to rise? Will the Fed act aggressively to cap its rise by raising interest rates several times this year? If so, will further Fed rate hike talk or an actual rate hike in April push the equity and precious metals markets lower? Or will consumer price inflation remain muted and thereby discouraging the Fed from further rate hikes? Were this week’s large price declines in the price of gold and silver a pause from further gains or the end of a mini bull market in gold and silver?
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This article does not necessarily reflect the explicit views of BGASC, nor should it be construed as financial advice.