Why the Fed’s Interest Rate Rise Will Crash Gold in June

Gold Chart 4

Gold has surged nearly 20% this year. After hitting a 15-month high, and breaching US$1,300 per ounce, most punters are turning bullish.

JP Morgan’s Solita Marcelli told CNBC last week, ‘We’re recommending our clients to position for a new and very long bull market for gold. US$1,400 is very much in the cards this year.

Dennis Gartman, Editor of The Gartman Letter, agrees. He believes the precious metal is on the verge of going much, much higher.

Gartman told CNBC’s Fast Money last Monday, ‘I think it’s still a bull market. I think the monetary authorities around the world, with the exception of the United States, are continuing to err on the side of easier monetary policies.

Gartman predicts gold will surge to US$1,500 per ounce by years’ end. This would be great news for gold punters. They’ve had a ripper of a ride this year. The Vaneck Gold Miners Index [ASX:GDX] has nearly doubled from its January low of roughly $18 per unit.

Unfortunately, I expect gold’s dream run to end soon. In my view, this is just another bear market rally. When it ends, gold punters are in for a nightmare ride.

I’ll explain…

Don’t shoot the messenger

If you’ve been following my work on gold, my bearish stance isn’t new. I’ve warned gold would crash to US$931 per ounce for nearly two and half years. It was trading at around US$1,350 per ounce when I first made the call.

I admit, when I first made this forecast, I imagined the worst would be over by now. I also believed we’d see a sharper crash towards my target. This hasn’t happened…yet.

Instead, it’s been a painful extended bear market, with multiple rallies. And this time should prove no different.

Of course, plenty of people think I’m wrong. Remember Bruce?

He wrote to the Money Morning mailbox last week, saying:

Hi Jason, Sorry you are not aboard the gold rally and as for Dudley read what Bill Bonner thought of his 2 rate rises yesterday!

I wonder if Bruce regrets his email. On 10 May, I argued the Fed would raise rates in June, saying:

I expect the Fed to raise rates this year. In fact, contrary to popular opinion, the first rate hike could be in June. If this happens, gold stocks are likely to start crashing soon.

The signal might not come until the end of the month. Remember, the Fed meeting is scheduled for 14–15 June. So there’s no urgency to rush a decision. There’s plenty of data, which the Fed claims to be watching, due out soon. Retail sales is an important variable.

If the Fed announces that it’s looking to hike, sentiment will change. The stock market, nor gold, is ready for a change in sentiment. Are you?

A rate hike seems more likely now. Before the Fed released its April minutes, I wrote last Tuesday:

Interest rate futures show a rate hike next month stand at 8%. The number compares to 46% a month ago.

It appears punters are wearing rose coloured glasses.

US retail sales grew last month, and at the fastest pace in more than a year. The economic conditions are ready for another rate hike.

If the Fed does move towards lift off next month, expect gold stocks to crash.

We didn’t have to wait long for a change in sentiment. According to the Wall Street Journal last week,

Federal Reserve officials sent skeptical investors a sharp warning Wednesday that an interest-rate increase is still in play for June’s policy meeting if the economy keeps improving.

Until a few days ago, traders in futures markets saw almost no possibility the Fed would move short-term interest rates up at midyear. However, a batch of strong economic data, recent comments by Fed officials and a new release by the central bank on the deliberations at its last policy meeting have changed that perception.

I can’t say I’m shocked.

Of course, while many tout the fact that the market’s always right, at times it’s a little slow to react. Our goal, as investors and traders, is to identify mispricing and value when it’s wrong. This is how you bank the big profits. Remember, if the market was always right, there wouldn’t be any point in trading.

With this in mind, the market got it wrong this time — and gold got wacked. After peaking at US$1,288.59 per ounce last week, gold fell sharply to US$1,243.72 on the news. It’s trading at US$1252.90 per ounce this morning.

Regardless of the action, many believe the Fed still won’t raise rates. After all, these ‘professionals’ change their mind more than a kid in a candy shop.

A rate hike is coming in June

Contrary to popular opinion, the US Fed has absolutely no choice BUT to raise rates. The Financial Times explains why:

Eighteen months after Rahm Emanuel, a former White House chief of staff, became mayor of Chicago, he addressed a news conference about his priorities.

“[Number] one is retirement security and pension reform so we can give taxpayers and the public employees retirement security, which is something we can’t say today,” the mayor said in November 2012.

In the following three and a half years, Chicago’s public pension system, which estimates suggest has a funding hole of between $20bn and $32.5bn, has cast a long shadow over the mayor.

The mainstream tends to underplay this story — similar stories are playing out across the US, which aren’t talked about. Many cities and states are struggling to fund pension plans for current and past public sector employees. This doesn’t include public pension funds, which are also rarely talked about. The Financial Times elaborates:

The scale of this pension crisis, as it has been dubbed, is huge. The Hoover Institution, a think-tank at Stanford University, estimates that US public pensions collectively have a $3.4tn funding hole. More conservative numbers put the funding gap at around $1tn.

Another factor is that public pension plans have been underestimating how much money they would need in future, says Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania.

Public plans typically have high return targets of between 7 and 8 per cent, which are used to forecast how much money a pension fund will need to pay current and future retirees. Private sector pension plans, in contrast, typically use lower rates of 2.5 per cent on average to calculate future liabilities, says Ms Mitchell.

Low interest rates are destroying pension funds. Unless the Fed raises rates, this will be an absolute bloodbath. The Fed knows it too, and has no choice but to raise rates.

While gold could pop higher in the short term — a nice courtesy rally, trapping the bulls — it should crash in the months ahead. When the rate hike rumours grow, which will inevitably change the sentiment, gold will reverse its trend.

If you made 100%-plus on the last bounce, good work. But I’m keeping things simple for Resource Speculator readers, which is an investment newsletter, not a trading service. We aren’t taking on the risk of profiting from a brief rally, and hoping to get out before it crashes. When the gold crash comes, it will be the time to buy the best miners. If you buy the best miners — at the right time — you stand to make the most gains over the long term.

That time isn’t yet. But when it arrives, my Resource Speculator readers will be ready.

Find out more by clicking here.


Jason Stevenson,
Resources Analyst, Money Morning

Ed Note: This article was originally published in Money Morning.


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