Why The Federal Reserve Might Help Gold Prices
The Federal Reserve last Thursday, October 13th decided to keep interest rates unchanged. While it was a bit of a close call (three dissenting votes wanted to raise rates) among the open market committee, Fed President Janet Yellen is firmly in support of keeping interest rates near 0 for the near term. She is calling it a “high pressure economy”.
Without getting too technical as to the Fed’s thought process, Yellen believes that the US is suffering from a demand side issue, as supply is currently outpacing demand. Keeping rates near 0 will hypothetically encourage businesses to invest in capital and expand, and hire more people. The benefits of businesses investing in capital can have long term positive effects for the economic growth rate. This type of move will also push the unemployment rate lower and should increase demand in the economy through full employment. Again, all of that being hypothetical as no one really has a crystal ball to see the long term effects.
The Consequence of Low Rates for Gold
There is another consequence to holding interest rates low. At some point, inflation will start to rise. The Fed is technically mandated by congress to hold the inflation rate around 2% annual inflation, but they have signaled that they may be willing to go above the mandate for a short period of time.
There is a big risk in this. Once inflation starts to rear its head and accelerate, it has already built a lot of momentum. It may not be easy to control it without a significant rate raise, which will almost certainly throw shocks across the economy and equity markets.
If Rates Stay Low
Inflation rates will rise. This means that hard assets like gold, silver, and platinum will appreciate in value at least keeping pace with inflation. Practically speaking, when people don’t want to hold cash they will move money into other assets, and this increased demand for gold will cause the price to rise even faster than it would if it were only keeping pace with inflation. Gold has always been used as a hedge against inflation.
Continued low rates would indicate a positive long term outlook for gold prices.
If Rates Rise Suddenly
If the Fed raises interest rates significantly in a short period of time, this will send shock waves through the equity markets. Suddenly, capital is expensive and business expansion will slow down, so the growth outlook for stocks is lowered. As stock prices sink, investors will look for safer areas to keep their money. Gold is one of the first places they will look. Precious metals have long been used as a haven for investment capital when equity markets are going through bear periods.
A sudden rate rise, or any other shock or correction to equity markets will be associated with a positive gold outlook too.
Is the Fed Serious?
So is the federal reserve really willing to run interest rates at near 0% levels in the long term and put up with inflation above the mandated level? Possibly, but probably not for too long. However when they do we will see an acceleration of inflation. As inflation accelerates, the fed will worry that it will spiral out of control, and they will be forced into making sharp interest rate increases. Gold will get a little bump as inflation picks up, and a big one when equity markets experience the shock of higher rates. If you want to take the Fed at their word and you think that they will increase inflation, you should consider gold as a serious investment.