Gold prices have dropped from $1,340 an ounce in September to around $1,130 now. The cause is the strengthening USD and the recent rally in the U.S. stock market that followed Trump’s surprise victory.
Plus, most people now expect at least a few rate hikes by the Fed. Gold rarely fares well in a rising real rates environment. Many investors wonder if gold has entered a lasting bear market. Or if this is the time to buy while prices are low.
The world is focused on the prospect of rising interest rates. Yet, the market is pricing-in modest rate increases. Here is why:
Fed Chair Janet Yellen highlights that the Fed policies will continue to be accommodative
Following the Fed’s December 13 and 14 meeting, Yellen acknowledged that the Fed is in a wait-and-see mode. Based on recent progress on the employment front, it is planning tightening. It asserts that these are modest adjustments.
Yellen thinks the damage done to the economy by the financial crisis and recession can be fixed with robust aggregate demand and a tight labor market. So far, Yellen and her fellow Fed governors have not been hawkish. This is in spite of the belief the market does not foresee that the Fed will pursue an aggressive tightening policy.
Years of loose monetary policy—coupled with Trump’s infrastructure, de-regulation, and fiscal plans—could unleash a time of economic expansion which would likely include inflation. Based on the Fed’s past behavior, we expect them to be slow to hike rates and catch up. Real rates may turn negative. It would be very favorable for gold prices.
Yellen pointed to negative interest rates as another tool if economy slows
There is also a very real chance the U.S. economy will not continue to move upward. It may even slip back into a recession. We are in the seventh year of economic expansion. Historically, we are overdue for a broad-based market contraction.
In spite of the hope that followed Trump’s win, it is possible that the honeymoon will be short lived for their administration. The challenge facing the U.S. and world economies are plenty.
The U.S. economy is in the headwinds of a strong dollar and over-indebtedness. Lower taxes and increased spending could tip the scale and cause a recession.
Abroad, political tensions in Russia, Syria, Iraq, and Ukraine are ongoing. Europe is in social crisis as they are dealing with a huge wave of immigration. Also, the European banking system is creaking under various strains. Add to this the risks of increasing nationalism and trade wars possibly started by Trump, and the next few years could be unstable to say the least.
Yellen is already on record as saying that negative interest rates are just “another tool in the arsenal.” All it would take is a couple of quarters of negative growth and the Fed would have “to do something.” Negative interest rates are likely one of the last tools in their arsenal. This is why Yellen has already been preparing us for that possibility.
We are in a unique situation today, in that any action from the Fed is unlikely to affect gold prices. Yellen’s comments over the last few months demonstrate that the Fed will only hike rates if they feel compelled to do so.