Could the Fed Kill Gold with Rate Hikes? History Gives Us the Answer

The Fed talk of interest rate hikes has already spooked the stock market, and some gold investors are worried. Common knowledge says that rising interest rates are bad for gold’s price. When we look to history, though, the story is completely different…

Could the Fed Kill Gold with Rate Hikes? History Gives Us the Answer
Photo by Eddy Billard

From Birch Gold Group

This week, Your News to Know rounds up the latest top stories involving gold and the overall economy. Stories include: How gold blooms in rate hike cycles, gold's unusual behavior, and the short-term gold price outlook.

More evidence that gold can outperform if a hiking cycle happens

Why does gold face a supposed headwind when interest rate hiking cycles happen? Is it fundamentals? Reason? As Adam Hamilton notes, it is little more than panic by over-leveraged investors. One good thing that can be said about this is that rate hikes get priced in far ahead and in succession. As far as the markets are concerned, three rate hikes have already happened.

But that's where speculators stop doing gold any favors. Hamilton asserts that traders of gold contracts should not be allowed to engage in the kind of market manipulation they do on a regular basis. The stock market's maximum leverage has been 2x since 1974. For gold, it's 31.3x. A contract with a $6,000 backing can and does control 100 ounces of gold. That's $187,500 in gold with today's average price of $1,875.

It's this oversight that causes speculators to exert an absurd amount of influence on the gold market. And it's that much worse considering their forecasts and panic are unfounded. Analyzing the 12 rate hiking cycles since 1971, Hamilton points out that gold only experienced mild losses during four of those. The remaining eight saw gold post massive gains throughout the cycle. The last time gold didn't post major gains during a rate hiking cycle was 1989, showing just how disconnected from reality market participants are.

The latest hiking cycle, the one between 2015-2018, kickstarted today's gold bull market. Gold started at $1,051 and was up by 17% within three years' time. Perhaps of far more interest is the rate hiking cycle that ended in 1979, because economic conditions then were similar to today. Rampant inflation and massive money printing.

During this hiking cycle, gold gained a stupendous 178.3%. That's because, for all the speculation, traders still know enough to flock into gold when inflation and currency debasement are peaking. Let's also take into account that stock market valuations are more than double their fair value. A correction will mean anything between a recession and a depression. Hike away, says the gold

Pinning down gold's correlations

A Washington Post article wonders why the inverse correlation between Treasury yields and gold seem to have dissipated. Just last month, the yield on the 10-year Treasury hit a 2-year high. Yet on Friday, gold hit $1,900 during the trading session, climbing ever so slowly to the 2011 high thought unreclaimable by many not too long ago.

Maybe the gold price is benefiting from Asian jewelry demand? In China, retail sales last year grew at their fastest pace since 2013, showing a recovery towards levels seen in 2019 and earlier. In India, jewelry sales have been even more rampant.

We know that India more than doubled its gold imports last year as paused weddings and celebrations would wait no longer, and jewelers rushed to meet demand. The physical gold market in India used to follow a sort of tradition where a decline in demand would come about whenever 10 grams of gold exceeded 30,000 rupees, or $400. So Indians would buy up gold at what they viewed as a bargain price under $1,200, but pulled back whenever the metal climbed past that figure.

It's nearly double that now, yet last year's gold demand in India was at its highest since 2017. There are many easy explanations for this, with one being that India is seeing the same gross currency devaluation like any other country in the world. And the explanation for why gold is posting highs alongside Treasury bonds is perhaps just as easy and straightforward.

On paper, Treasuries are doing well. But in essence, they represent U.S. debt and require faith in the dollar. It's well known that the global bond market has all but collapsed, with the Treasury the last sovereign bond offering any above-zero yield. It's equally known that the U.S. has printed trillions of dollars over the past two years.

Is it that big of a stretch to say that investors simply trust gold over Treasury bonds as a safe haven investment?

A look into gold's short-term price drivers

Recently, Kitco spoke to a few analysts about how the markets are feeling and why gold has been soaring. The prevalent theme is uncertainty. With as much economic weakness on all sides, gold hardly needed massive geopolitical tensions to flourish. But they have been added to the mix, and the metal responded.

OANDA's senior market analyst Edward Moya believes these will go on for some time, providing a considerable boost for gold. And then we get to the real drivers that have been slowly pushing the metal towards a new all-time high. Right now, we're hearing the infamously optimistic Wall Street use the word recession.

Investors are worried about where the economy will be in the next 12-24 months, and with good reason. Before the stimulus, global economic growth was either stagnating or plummeting, depending on the country. Then came the stimulus, which might have convinced some that the economy is doing well. But many weren't, and now that central banks are looking to tighten, very few will. As both money printing and balance sheet purchases ease, we're likely to see just how strong the economy's foundations are. And it's a sight many might want to look away from.

Then there is, of course, inflation. Kevin Grady, president of Phoenix Futures and Options LLC, said that inflation is making gold very appealing to those looking to shed risk from stocks and crypto. In reality, however, it's making gold look appealing to everyone. Grady specified:

A lot of the gold's price moves are coming from the inflation story. We see inflation hitting 7.5%, which is a 40-year high. But if we use the same metric to measure the consumer price index (CPI) as in 1980, our inflation would be closer to 15%. People are realizing this, which is why gold is finally rallying. The Fed has no handle on inflation, and the energy market is facing a lot of pressures from high demand. Everyone is waiting for this Federal Reserve meeting in March to see how the central bank will approach inflation.

And, as the first story reminded us, the last rate-hike cycle pushed gold up by 17% in three years. We wouldn’t be surprised to see the same thing happen again.

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