When financial markets panic, gold is never far from the picture. So it proved the case again last week, following the US Federal Reserve’s decision to keep rates on hold.
Markets, as they have a habit of doing, lost their nerve. The ASX closed below 5,000 points for the first time since 2013. Global markets didn’t fare any better.
Yet volatility always has its upsides. Especially when it comes to gold. The safe-haven asset is having something of a renaissance.
US gold prices climbed to their highest level in four weeks. Futures contracts for December rose by US$22.30 on the New York Exchange. That’s up 2% to US$1,158 an ounce.
Aussie gold is up too. Since the start of September, gold prices are fetching AU$20 more, at AU$1,645 an ounce.
This retreat to safer assets is a natural reaction to market volatility. And it might also explain why the Fed chairwoman, Janet Yellen, returned to the podium overnight to address the press.
Her speech was a vain attempt at easing concerns and restoring confidence in markets. In typical Yellen fashion, she sent mixed messages:
‘Most [Fed] participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter’.
Then came the sweetener:
‘But if the economy surprises us, our judgements about appropriate monetary policy will change’.
In other words, the Fed’s definitely raising rates. And nothing will stop them — other than the economy…the same obstacle that’s kept rates at near zero for nine years.
Every time Yellen speaks, gold looks more attractive as an investment. She’s developing something of a knack for spruiking gold. Call it a ‘Yellen-ism’.
You’d give her some slack if this was a Freudian slip. But this was premeditated speech with planned, if not always truthful, motives. Yet if it’s meant to convince markets of stability, the Fed’s doing a poor job.
Of course, the Fed doesn’t really care what markets make of what they say. Every word Yellen utters should be taken as doublespeak. It’s deceptive on purpose. The Fed has little intention of revealing its actual plans for its monetary policy.
But let’s play along. Let’s say Yellen is being genuine.
The US economy, if you believe the Fed, is doing just fine. More than that even. Yellen said strong growth was reducing slack in the economy. So much so that the Fed says inflation will ramp up in the coming years.
Rising inflation is important because the Fed sees it as a barometer for its rate policy. If inflation exceeds 2%, it leans towards rate hikes. Higher rates decrease the amount of money floating around in the system. Which is why central banks place so much focus on inflation. If an economy isn’t overheating, which inflation might suggest, there’s less reason to lift rates.
Yet US inflation is running at 1.6%. And it explains why the Fed’s confident about maintaining rates at present levels.
Yellen alluded to some of the pressures weighing on inflation. She talked about the strong US dollar. She mentioned low oil prices and falling import prices. Both were helping lower the price of consumer goods.
But the Fed believes inflation will start rising as these pressures ease. This, in its view, will open the door for rate hikes. Why the Fed remains so sure of this is unclear.
Market inflation expectations have fallen to their lowest level since 2009. Inflation isn’t, and won’t be, a problem anytime soon. Certainly not by this year, assuming the Fed carries out its threat for a rate lift off.
Yet the outlook for the US economy isn’t optimistic. There’s a growing queue of economists questioning the Fed’s assessment. One thing everyone is watching is the impact of decelerating global growth on the US economy. And how this will affect global deflationary pressures too.
Deflation isn’t good for economic growth for a simple reason. If people expect lower prices in the future, they stop spending. When people won’t spend, economies don’t grow. And central banks have no option but to ease monetary policy even further.
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Don’t believe Yellen that a rate rise is coming in 2015
Tightening credit looks a less viable option than it ever has. Because of this, the Fed could be forced into a U-turn.
When deflation takes hold, central banks fall back on their old tricks. They combat deflation by opening the door to further stimulus measures.
Whether that happens as a result of lower rates isn’t important. The Fed could send rates into negative territory if it wanted to. Nothing’s stopping them from doing so. European and Japanese policymakers central banks have set the precedent.
Negative interest rates are simple enough to understand. Depositors get charged for storing money in banks. Which sounds as absurd as it is. If you paid fees on your savings, you’d probably start walking around with a whole lot more dollar notes in your pockets.
I don’t expect the Fed will enter negative rate territory over the next year. Not least because it’s a bad look for them. But there are other ways to stimulate economic activity without touching interest rates.
For instance, the Fed could resume its bond-buying program. Purchasing bonds would clear the way for further public spending across the economy.
That’s where I see things heading for the time being. At least until the middle of 2016, at which point all bets are off. We’ll get a much clearer picture for where the global economy is, and where it’s heading.
Just don’t take the Fed’s word on anything until then.
Yellen might talk about a ‘prudent’ approach. One in which rates rise gradually, starting this year. She might even feign concern about what it will mean if rates remain untouched. When it’s too late. When the economy overheats, and rampant asset speculation takes hold.
Yellen says all this, but she doesn’t really care. The Fed hasn’t cared for the better part of a decade. After all, it knows a thing or two about asset speculation.
Its rate policy is largely responsible for today’s bloated share markets and high P/E ratios. Not just in the US, but the world over.
The levers of US rate policy are responsible for shifting vast sums of capital into emerging markets. The kind of money these economies couldn’t possibly sustain long term. Most of this capital propped up flimsy stock and property markets. And we’re supposed to sit here looking shocked that global markets are tanking…
As this speculation has unfolded since 2008, safer assets lost big time. Gold and cash suffered most.
But the time is right for a comeback. The future for gold looks bright. As long as the Fed plays its game of doublespeak, we’ll have no idea when rates will start rising — if ever.
The longer this goes on, the better things look for bullion. Gold bugs can thank Ms Yellen for that.
Contributor, The Daily Reckoning
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