When the Fed raised interest rates in December, many believed gold prices would plunge. But it didn’t happen.
Gold prices bottomed the day after the rate hike, but then started moving higher again. And for the last 10 weeks it’s been up about 12%, despite some up and down fluctuations.
Incidentally, the same thing happened last year when the Fed tightened in December 2015. Gold had one of its best quarters in 20 years in the first quarter of 2016. So it’s very interesting to see gold prices going up despite headwinds from the Fed.
Normally when rates go up, the dollar strengthens and gold weakens. They usually move in opposite directions. So how could gold prices be going up when the Fed’s tightening and the dollar’s strong?
That tells me that there’s more to the story, that there’s more going on behind the scenes that’s driving the gold price higher.
It means you can’t just look at the dollar. The dollar’s an important driver of the gold price, no doubt. But so are basic fundamentals like supply and demand in the physical gold market.
I travel constantly, and just in recent months I was in Shanghai meeting with the largest gold dealers in China. I was also in Switzerland not too long ago, meeting with gold refiners and gold dealers.
I’ve heard the same stories from Switzerland to Shanghai and everywhere in between, that there are physical gold shortages popping up, and that refiners are having trouble sourcing gold. Refiners have waiting lists of buyers, and they can’t find the gold they need to maintain their refining operations.
And new gold discoveries are few and far between, so demand is outstripping supply. That’s why some of the opportunities we’ve uncovered in gold miners are so attractive right now. One good find can make investors fortunes.
My point is that physical shortages are becoming an issue. That is an important driver of gold prices.
Now, when we talk about the gold market, it’s very important to distinguish between the paper gold market and the physical gold market. When I refer to the paper gold market, I’m talking about gold ETFs, COMEX gold futures and the like.
There’s only a small amount of gold backing these markets. Think of an inverted pyramid, with a small amount of gold at the bottom supporting a vast amount of paper gold contracts on top.
So the paper market is not an honest reflection of the physical gold market.
And there’s no question that the paper gold market has been manipulated downwards. That’s not a conspiracy theory. I’ve spoken to expert witnesses in some of the pending litigation involving price manipulation. These are PhD statisticians who’ve looked at 20 years of data and tell me there’s no question that the paper gold market is being manipulated.
Who’s behind it, and their motivation, is a matter of some speculation. But more importantly, gold prices have been moving higher despite higher interest rates and price suppression through the paper gold market.
That tells me we’re seeing a flight to quality, meaning people are losing confidence in central banks all over the world. They realize the banks are out of bullets. They’ve been printing money for eight years and keeping rates close to zero or negative. But it still hasn’t worked to stimulate the economy the way they want.
So gold has been moving up in what I would consider a challenging environment of higher rates and a manipulated paper market. The question is, where does gold go from here?
First, I think the Fed’s on track to raise rates in March. As I’ve been saying since last December, the Fed is on track to raise rates in March. The market gave this a 30% probability until recently while I gave it a 75% probability.
Now the market has moved to a 70% probability just in the past few days. I’ve moved to the 90% confidence level. It’s “game on” for a rate hike on March 15.
The logical question is, “If the Fed’s raising rates, doesn’t that make it a more difficult environment for gold?”
I’ve partly answered that question. But there’s more to it…
The Fed is raising at the worst possible time, if we bring President Trump and his economic plan into the equation. Here’s what I mean…
The stock market has gone up 2,000 points, or more than 10% since Trump was elected. The expectation was Trump would mean lower taxes, more infrastructure spending, more defense spending, less regulation, and all this would help the economy.
Now, the last time gold sold off dramatically was on election night, when Stan Druckenmiller, a famous gold investor, sold all his gold. It’s only natural that when someone dumps the amount of gold he deals in, the price will go down.
That move reflected a change in sentiment.
What Stan said at the time was very interesting. He said, “All the reasons that I own gold in the first place have gone away because Trump was elected president.”
In other words, he was buying into the story that Hillary Clinton would be bad for the economy but Donald Trump’s policies would be beneficial. If we were going to have strong economic growth with a Trump presidency, maybe you didn’t need gold for protection. So he sold his gold and bought stocks on the assumption that the economy would grow under Trump.
But just in the past couple weeks, Stan has said he’s buying gold again. What that means is that after the initial Trump euphoria, people are now reconsidering the reflation trade. They’re wondering where the money for all this infrastructure spending is going to come from.
If our debt-to-GDP ratio is already over 100% and we’re 20 trillion dollars in debt, there doesn’t seem to be much room for more debt. And the faction of Republican budget hawks in Congress are saying that tax cuts must be paid for, meaning spending cuts elsewhere or raising taxes somewhere else.
That means for the economy as a whole, there is no tax cut. If you make tax cuts revenue neutral, which means that for every dollar cut you’ve got to raise it someplace else, there’s no simulative effect.
Plus, the infrastructure spending looks like that’s already been put off to 2018. And the deregulations Trump promised sound good, but they’ll take a very long time to play out.
So many are taking a closer look at the Trump reflation trade and concluding there’s a lot less there than meets the eye. And we also need to realize that the Fed looking to raise rates, even though the economy might not be as rosy as many originally thought.
But the reason the Fed wants to raise rates is telling.
It’s not because they think the economy’s strong — we might even be looking at negative GDP for the first quarter — but because they’re worried they’ll have to raise them before the next recession arrives.
So the Fed is on a mission to raise rates as soon as possible so they can cut them when the recession comes. That’s a very strange reason to be raising rates, but that’s why.
They should have raised rates in 2011 but didn’t. If they raised then, they’d be in a good position to cut rates today, but they didn’t. Now they’re trying to make up for lost time, but as usual the Fed’s getting it wrong.
So the Fed’s raising rates in the face of a weak economy. That will become obvious and by April or May the Feds going to have to reverse course.
What’s going to happen when the Fed reverses in April or May?
Gold’s going to go higher again, because people are going to realize the Fed can’t raise rates even though they want to. They’ll have to cheapen the dollar again, and that’s very bullish for gold prices.
To sum it all up, I’m very impressed with the present gold action because it should be going down based on higher rates and price suppression of the paper gold market. But it’s not, it’s rising.
So I expect gold prices to really take off in the spring. – Jim Rickards
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