Gold Now Poised to Move Higher as the Fed Rate Hike Cycle Continues
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Earlier this week, all eyes were glued and computer trading algorithms set to the Federal Reserve two day meeting speech which was released at 2pm EST on the Ides of March 15th. As soon as Fed chairwoman Janet Yellen delivered pretty much what everyone was expecting, the stock market, gold, silver, and oil all rallied as the committee’s vote was 9-1 in favor of raising interest rates another 0.25 basis points.
This news immediately triggered computer algorithm based trades to sell the US Dollar and buy the precious metals sector with a “fade the news” reaction. As gold rose nearly 2% from major support at $1200, the junior miner ETF index GDXJ zoomed over 11.5% higher on record volume. A very impressive feat considering most of the volume took place in the last two hours of trade after the Fed announcement.
The GDX also had a large volume move higher as I believe we now have a very good chance of a higher low being in place on the major miner ETF. However, I would still like to see a weekly close above $26 in the GDX before being completely confident of a long term bottom being in place for the miners.
Yellen said the Federal Reserve focus would be stabilizing inflation as it continues to increase after a long period of sideways movement. I see the market as shifting focus to the inflation showing up in the US economy which has begun to cause all assets to rise in unison after nearly a decade of record low interest rates.
The Fed’s forecasts have now moved in the direction of tightening as they remain on pace with three hikes in total this year. Their main focus is on stabilizing inflation with the most serious stimulus being the continued rise in stock prices as global capitol continues to flow into US blue chip equities. The market has now priced in a 78% chance of a rate hike in September and a 58% chance of a third 2017 rate hike in December.
When the COMEX closed a half hour before the Fed announcement, gold had been down 11 of the past 12 sessions. In previous posts I have mentioned this gold sector sell off would most likely end around the time this major market catalyst was announced. The Feds interest rate policy announcements, along with the very influential Non-Farms Payroll (NFP) reports, have been among the biggest catalysts in either direction for the gold price since the Fed began the rate rise cycle in December 2015.
Just last month, the commercial short position in silver was the largest on record. The Commitment of Traders (CoT) report, which was issued on March 10th, showed the “smart money” commercial traders beginning to cover their shorts in the metals earlier in the week as gold and silver became over-sold. Short covering typically accelerates an
asset gain because an investor making a short bet is forced to essentially buy the asset back at higher prices in order to mitigate losses from gains.
The miners also reversed in early trade just before the CoT report was issued last Friday and bottomed three trading days before the expected Fed rate hike announcement. Miners typically lead the metal as they also began correcting very hard a week before gold in February.
The last time the Fed embarked on an interest rate rise cycle was nearly thirteen years ago. They began to raise rates on June 30th, 2004 from the 1% Fed funds level while gold was trading slightly below $400. Just before the Fed got to 5.25% in the Fed funds rate in May of 2006, gold was trading well above $700. A comparable percentage gold move in two years time from December 2015 would be well above $1800 per ounce by the end of 2017. I am not predicting this, but I believe it is becoming more evident the Fed has been instrumental in fueling the next leg of a multi-decade gold bull market after the first Fed funds rate rise in nearly a decade on December 14th, 2015.
The nominal five year yield is at just over 2%, but the real five year yield is now negative at -0.03%. Inflation determines the difference between nominal and real interest rates. Nominal interest rates are before taking inflation into account, while real rates are nominal rates adjusted for inflation. Gold prices tend to increase significantly only during the periods of negative real interest rates as it reclaims its traditional role as money and a store of wealth, which will at least keep pace with inflation to preserve the purchasing power of capital.
Core inflation since the election of Donald Trump has risen to a five year high. While inflationary pressures continue to rise, I believe the Fed will not dare to get ahead of the inflation curve with these proposed “gradual” moves higher in the Fed funds rate. This should guarantee negative real rates for perhaps years to come, driving more investors to park investment capitol into bullion.