Gold, Interest Rates and Super Cycles
When the Fed raised interest rates last December, many believed gold would plunge. But it didn’t happen.
Gold bottomed the day after the rate hike, but then started moving higher again.
Incidentally, the same thing happened after the Fed tightened in December 2015. Gold had one of its best quarters in 20 years in the first quarter of 2016. So it was very interesting to see gold going up despite headwinds from the Fed.
Meanwhile, gold has more than held its own this year.
Normally when rates go up, the dollar strengthens and gold weakens. They usually move in opposite directions. So how could gold have gone up when the Fed was tightening and the dollar was strong?
That tells me that there’s more to the story, that there’s more going on behind the scenes that’s been driving the gold price higher.
It means you can’t just look at the dollar. The dollar’s an important driver of the gold price, no doubt. But so are basic fundamentals like supply and demand in the physical gold market.
I travel constantly, and I was in Shanghai meeting with the largest gold dealers in China. I was also in Switzerland not too long ago, meeting with gold refiners and gold dealers.
I’ve heard the same stories from Switzerland to Shanghai and everywhere in between, that there are physical gold shortages popping up, and that refiners are having trouble sourcing gold. Refiners have waiting lists of buyers, and they can’t find the gold they need to maintain their refining operations.
And new gold discoveries are few and far between, so demand is outstripping supply. That’s why some of the opportunities we’ve uncovered in gold miners are so attractive right now. One good find can make investors fortunes.
My point is that physical shortages have become an issue. That is an important driver of gold prices.
There’s another reason to believe that gold could be in a long-term trend right now.
To understand why, let’s first look at the long decline in gold prices from 2011 to 2015. The best explanation I’ve heard came from legendary commodities investor Jim Rogers. He personally believes that gold will end up in the $10,000 per ounce range, which I have also predicted.
|This means the 50% retracement is behind us and gold is set for new all-time highs in the years ahead.
But Rogers makes the point that no commodity ever goes from a secular bottom to top without a 50% retracement along the way.
Gold bottomed at $255 per ounce in August 1999. From there, it turned decisively higher and rose 650% until it peaked near $1,900 in September 2011.
So gold rose $1,643 per ounce from August 1999 to September 2011.
A 50% retracement of that rally would take $821 per ounce off the price, putting gold at $1,077 when the retracement finished. That’s almost exactly where gold ended up on Nov. 27, 2015 ($1,058 per ounce).
This means the 50% retracement is behind us and gold is set for new all-time highs in the years ahead.
Why should investors believe gold won’t just get slammed again?
The answer is that there’s an important distinction between the 2011–15 price action and what’s going on now.
The four-year decline exhibited a pattern called “lower highs and lower lows.” While gold rallied and fell back, each peak was lower than the one before and each valley was lower than the one before also.
Since December 2016, it appears that this bear market pattern has reversed. We now see “higher highs and higher lows” as part of an overall uptrend.
The Feb. 24, 2017, high of $1,256 per ounce was higher than the prior Jan. 23, 2017, high of $1,217 per ounce.
The May 10 low of $1,218 per ounce was higher than the prior March 14 low of $1,198 per ounce.
The Sept. 7 high of $1,353 was higher than the June 6 high of $1,296. And the Oct. 5 low of $1,271 was higher than the July 7 low of $1,212.
Of course, this new trend is less than a year old and is not deterministic. Still, it is an encouraging sign when considered alongside other bullish factors for gold.
But more importantly, gold has held its own despite higher interest rates and threats of more.
That tells me we’re seeing a flight to quality, meaning people are losing confidence in central banks all over the world. They realize the banks are out of bullets. They’ve been printing money for eight years and keeping rates close to zero or negative. But it still hasn’t worked to stimulate the economy the way they want.
So gold has been moving up in what I would consider a challenging environment of higher rates.
The question is, where does gold go from here?
The market is currently giving close to 100% odds that the Fed will raise rates next month.
I disagree. I’m skeptical of that because of the weak inflation data. There will be one more PCE core data release before the Dec. 13 meeting. That release is due out on Nov. 30.
If the number is hot, say, 1.6% or higher, that will validate Yellen’s view that the inflation weakness was “transitory” and will justify the Fed in raising rates in December.
On the other hand, if that number is weak, say, 1.3% or less, there’s a good chance the Fed will not raise rates in December. In that case, investors should expect a swift and violent reversal of recent trends.
Markets have priced a strong dollar and weaker gold and bond prices based on the expectation of a rate hike in December. If that rate hike doesn’t happen because of weak inflation data, look for sharp rallies in bonds and gold.
Now, the last time gold sold off dramatically was on election night, when Stan Druckenmiller, a famous gold investor, sold all his gold. It’s only natural that when someone dumps the amount of gold he deals in, the price will go down.
That move reflected a change in sentiment.
What Stan said at the time was very interesting. He said, “All the reasons that I own gold in the first place have gone away because Trump was elected president.”
In other words, he was buying into the story that Hillary Clinton would be bad for the economy but Donald Trump’s policies would be beneficial. If we were going to have strong economic growth with a Trump presidency, maybe you didn’t need gold for protection. So he sold his gold and bought stocks on the assumption that the economy would grow under Trump.
But earlier this year, Stan has said he’s buying gold again. What that means is that people are finally reconsidering the reflation trade. Tax reform is still a big question mark. And when’s the last time you heard a word about infrastructure spending?
Investors will once again flock into gold once reality sets in. Mix in rising geopolitical tensions in Asia and the Middle East, and gold’s future looks bright.