Misconceptions Abound on Effects of Rate Hikes on Gold; Gold Price Forecast 2017 Points Higher
The interest rate tightening cycle is upon us. The market expects at least three additional 25-basis-point rate hikes leading into 2018. Common group-think may reason now is a good time to sell gold. But that’s not necessarily the case. Nor is following the crowd a reliable way to make money. Although gold prices today have been range-bound for five years, a resolution is coming sooner rather than later. Our gold price forecast 2017 reflects the fact that while rising rates aren’t necessarily bullish, stronger buy-side catalysts should overcome the “opportunity risk” of owning gold.
So what exactly do we mean by the “opportunity risk” of owning gold? Simply put, bonds and dividend-paying stocks also pay higher rates when the Fed hikes interest rates, so the “cost” of owning gold gets more acute. Of course, since gold has no yield, logic states it’s more expensive to hold gold during these periods. But is the logic correct? Or is this financial fake news? Well, it’s a little bit of both.
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In theory, the logic is sound. But the market doesn’t always react that way. That’s because investors invest on expectations more than anything else. By the time the Federal Reserve acts, rate hikes are priced in. The market is forward-looking.
For instance, a July 2015 HSBC study found that gold prices actually increased during the past four Fed hiking cycles. “History shows that gold prices also fall leading into a rate hike and generally rise, though sometimes with a lag, after the first rate hike…” (Source: “Here’s What Happens to Gold When Interest Rates Go Up,” Casey Research, December 17, 2015.)
The gold price chart below gives a visual example of the price of gold during past rate hike cycles. This chart shows how gold reacted during the 2004 tightening cycle, in response to a robust economy post-Tech Bubble.
Effects of Increased Rates on Gold Prices
So far, the playbook has stayed true to form. Gold prices per ounce fell precipitously before the Fed’s first rate hike, only to increase afterwards. Gold was around $1,800/ounce in fall 2012, only to drop to $1,060/ounce by the time the Federal Reserve started raising rates in December 2015 (by 25 basis points). That first rate hike coincided exactly with the secular low in prices.
The same thing occurred after the Fed’s second rate hike in December 2016. Gold prices were mired at 10-month lows ($1,135/ounce) only to rebound north of $1,250/ounce in 1.5 months after the second hike. History seems to be repeating itself, and it’s telling us that rate hikes aren’t the driving factor in price.
What is the driving factor then? Most likely, gold is being purchased on dips as a hedge against a severe stock market decline and future monetary debasement—a fourth round of quantitative easing (QE), perhaps? Astute investors are aware of how rate hikes could torpedo the economy by making the cost of borrowing prohibitively high. Consumers and businesses are very price-sensitive and oversaturated with debt as is. If the economy goes into recession, surely one of the highest valuation markets ever will crash, leading investors into the comforting arms of gold.
Remember, the American economy is all about credit growth. Once the inevitable slowdown in commercial borrowing happens, the business cycle ends. It’s really that simple. This is precariously close at hand.
Thus, our gold price forecast 2017 calls for higher prices, veering towards $1,500 per ounce by the time the interest rate hike cycle winds down. That will most likely be sometime in 2018 or 2019, but gold purchasing on the dips starting in 2017 could be your friend. If the stock market craters and causes a massive new debt stimulus and/or the Fed reverses course on reducing its balance sheet and starts expanding it again, all bets are off. Gold prices have the potential to go much higher, especially in conjunction with a weaker dollar.
We believe the market is on the cusp of rediscovering “value investing” again. Cheap assets will come back in vogue; expensive ones will wilt. Gold and silver belong in the former camp. Not only will they protect your portfolio against calamity like they always have, they may become stellar capital-appreciating stars when paper assets become mired in a sea of red.
