Most pundits on Wall Street (the CNBC types) are nearly universal in seeing the interest rate increase as negative for gold. Especially vocal in this regard has been Goldman Sachs. One headline this week screamed “Gold sags as higher U.S. rates are ‘very negative’ for bullion.”
I couldn’t disagree more, and the historical facts clearly show this.
Just like they were completely blindsided by the most severe stock market crash since the depression in 2008, I believe they will eat their cake on this one, too.
To get you up to speed, on Wednesday morning, the CPI report for January indicated that prices for goods and services rose by the most they have in 4 years. On a year-over-year basis, the consumer price index rose 2.5%, its biggest gain in 5 years. This is that glorious inflation the Fed has been so eagerly trying to attain.
Using the government’s very own statistics, with the latest CPI data, the 10-year real yield went negative for the first time (on a downside trend) since May 2011. Prior to this, the previous occasion was in November 2007. And, by the way, neither of these times proved to be ideal times to be overly exposed to stocks.
The fact is that gold historically thrives in this environment!
Look at the last time the Fed substantially raised interest rates and how gold responded to the rate hikes.
Fed Funds Rate and Gold Price (USD) – 2003 to 2007
Consider the 1970s. This was following the historical official abandonment of what was left of the gold standard. By the way, at the time, experts feared that removing gold completely from the backing of the dollar would cause gold to crash. But what was quickly proved was that you can take gold out of “money” but you can’t take the MONEY out of gold.
The Federal Funds Rate rose from below 4% in 1971 to over 18% in 1980. During the same period, gold rose by 2,400% – from $35/oz. to $850/oz.
Rising interest rates led to a historic bull run in gold like we had never seen.
The chart below clearly illustrates that gold has responded very positive a number of times throughout history whenever the Fed decided that it was best for the economy to raise interest rates.
Counterparty Risk-Free Assets Perform Well in a Negative-Yielding Interest Rate Environment
Negative real interest rates are a positive occurrence for non-yielding assets. You can see how gold clearly responds directly when real yields fall. With real returns going fully negative, we could really see precious metals go on a tear here if history repeats, or at least rhymes.
Although, it wouldn’t surprise me to see the most recent pause in gold go a little deeper over the near-term, as the inflation data might incentivize more hawkish expectations with the Fed.
The fact is that yields being negative is a symptom of the struggling economy, and investors are going to seek safety as reality sets in. The Fed is jawboning that there will be 3 interest rate hikes this year. I highly doubt they will get this far, but even if they do, I fully expect gold to perform very well, with serious implications to the underlying mining shares. Precious metals will eventually reflect the breakdown in real yields that have largely been overlooked as equities make new highs.
Even after the rate hike, interest on deposits will remain near zero, and are negative when inflation is taken into account. Thus, savers are losing money when keeping their cash on deposit, and today, they are also at risk of having their savings expropriated due to the real risk of bail-ins in most G20 nations.
I have said this before and I will say it again: I consider buying gold under $1,300 and silver under $20 a huge blessing. It won’t be too much longer that you will be dreaming about opportunities to accumulate at these prices and be stuck buying much higher.
Chief Editor, CrushTheStreet.com