After a long year of sitting on the sidelines, the Federal Reserve is likely to start raising interest rates as soon as next month. They found reason after reason to hold off throughout the majority of 2016. For March, they abstained from higher rates because the jobs report came out extremely weak. When June came around, they punted because of the market volatility and fears regarding the world economy. In July they were afraid of a Brexit referendum results induced contagion. By September, their excuse was that they still waited for an improvement in the U.S. jobs market. In October they played their last holding pattern card with the impending American election. They did not want to influence the outcome by causing a recession or financial crisis with higher rates, so they held off yet again.
Higher Interest Rates Could Be In The Cards Now
What little recovery the economy has seen over the last eight years has emerged because of the unprecedented low cost for consumers and businesses to borrow money. Despite the fact that the U.S. economy is fully addicted to cheap money provided by near zero interest rates you have experienced since 2008, the Fed is highly likely to at last raise rates in December. The election is over; Trump has been elected; and the lion’s share of the uncertainty for the future of the country is now behind us.
His election probably means that the interest rates will be going higher much quicker than analysts had predicted. This is because Trump’s future plans for America are vastly different than Clinton’s would have been. He intends to increase the growth of the U.S. economy through fiscal stimulus, also known as aggressive government spending. Trump’s plans will at last force the Fed’s hand in ratcheting up rates faster than they would like. Bloomberg put it best with Commonwealth Bank of Australia’s Adam Donaldson’s remarks, “We do view the election of Donald Trump as a game changer. The strong bias toward fiscal expansion and inflationary policy represents a stark change to the malaise of recent years. This opens the door for the Fed to hike in December, but also more quickly in 2017 and 2018 than previously expected.”
Gold Prices Are Down on Fears of Higher Interest Rates
Higher interest rates mean that money is more expensive to borrow and deploy. Many analysts and investors have begun to fear that the higher cost for money will spell doom for gold and the precious metals. After beginning the post election period with a rally gold prices managed to tumble 6.1% lower by the end of the week. This drop had gold priced at its cheapest since last April.
The fears come from a common perception that higher interest rates negatively affect gold. Because gold does not provide any yield or interest like a bond, there is an opportunity cost in holding it as interest rates rise. This is why a number of investors do not want to keep gold when they believe rates are header higher. Still, there are several good reasons not to sell your gold now.
The Last Rate Increases Have Meant Higher Gold Prices
Over 80 percent of the market concurs that the Federal Reserve will at last raise rates before the conclusion of the year. Despite this near unanimity of opinion, it is not correct to assume that interest rate increases always result in lower gold prices. Consider that during the past four rate increases by the Fed, the price of gold has responded by increasing.
This chart below demonstrates clearly how gold prices have actually risen dramatically following Fed interest rate tightening. In fact, after the Fed began to aggressively raise rates in 2004, gold prices ran up 20 percent over the next six months. This all means that gold can still outperform even when interest rates rise quite rapidly.
Trump’s Inflationary Policies Will Be Good For Gold
Investors are beginning to wake up to the fact that Trump’s fiscal spending policies will spur inflation. Inflation causes the prices of tangible hard assets like gold to rise in paper U.S. dollar terms. Trump’s victory speech outlined his desire to spend a trillion dollars over a ten year period on rebuilding the nation’s crumbling infrastructure. The higher inflation this creates will be good for gold prices, as Alex Merk of Merk Investments pointed out.
“The general consensus is that fiscal spending is far easier to achieve than other reforms he has proposed. That should underpin the appeal of gold as an inflation hedge. Ultimately, what is going to matter is if inflation is going to tick up more than rates are going to pick up–meaning is the Fed going to be behind the curve or not? If the Fed is behind the curve, then gold should do just fine; if however the Fed is able to get in front of this or if inflation is not going to materialize much but the yield curve remains steep and real rates rise, then yes, the gold selling is over,” said Alex Merk.
Gold Is Still the Ultimate Protection Against Financial Chaos
Just because the U.S. election has been decided does not mean that everything is rosy with the global economy, the U.S. and European financial systems, and the future. Gold is the embodiment of real money that provides the greatest possible protection against potential financial chaos. Uncertainty regarding the economy and financial system is still rife.
One thing that is far less uncertain is that Trump is about to embark on a spending spree to rebuild the crumbling national infrastructure. Trump campaigned hard on his pledge to invest heavily in new and improved national infrastructure. He has promised “thousands of new jobs in construction, steel manufacturing, and other sectors to build the transportation, water, telecommunications, and energy infrastructure.” The problem is there is no extra money in the budget for this spending, which will all have to come from increasing the debt.
An independent think tank The Committee for a Responsible Federal Budget has analyzed his projected additional spending. They come to the worrying conclusion that already enormous U.S. debt levels will explode as a result of the fiscal spending Trump plans. Their prediction is that at the end of ten years, the government debt to GDP ratio will climb by a dangerous one-third more. Now more than ever is the time to hold on to your gold financial insurance policy.