THE FEDERAL RESERVE RAISES INTEREST RATES AND GOLD RALLIES. WHY?
The Federal Reserve (“Fed”) raised interest rates yesterday. According to many pundits, that is bad for gold prices. Get out now while you can!! This is consistent with the misconception many people have that higher interest rates are always bad for gold. Despite this sentiment, gold rose by 1% on Wednesday. Why – because the Fed said it only sees two more rate increases for the rest of this year. A perfect illustration of the gold’s performance during a period of interest rate increases occurred during the time period from July 2004 to July 2006. This was a period of aggressive interest rate increases (see chart below provided by Sprott Asset Management). Yet gold rose by more than 60%.
So can gold rise with more interest rate increases ahead? Yes. The reason is inflation. Even though short-term interest rates rose yesterday, rates are still below the current rate of inflation. We believe the government issued inflation rates (CPI and PPI) are much lower than what inflation is in the overall economy. This fact is reflected in the MIT Billion Prices Project that looks at prices for goods on line. That index shows that cost of goods has risen 3.6% year-over-year through the end of February.
Similarly, President Trump is working hard to bring jobs and businesses back to the United States. If he is successful, and with the unemployment rate currently under 5%, employers will have to raise wages to attract skilled workers. Add in that both Europe and Japan have negative interest rates and the recipe for rising inflation brews a little hotter.
What does this mean for your portfolio?
It has been more than 3½ decades since we experienced meaningful inflation in the United States. We believe the Fed is way behind the curve. Yesterday’s gold price action confirms our assessment that two more rate increases this year is not enough to keep inflation below the 2% stated objective of the Fed. During a time of rising inflation, hard assets like gold, real estate and commodities tend to outperform the stock and bond markets. We have a meaningful position in commodities (energy, gold, and managed futures) because we believe those investments are undervalued on their own. Adding inflation to the mix makes those investments more compelling.