The Critical Change for Gold Prices that Remains Un-noticed
Last week, everyone focused on the stock market sell-off. Reasonably enough, given the pace of the declines. But the analysts failed to pay enough attention to the very important shift. That change may be more important than Trump’s victory in the presidential election. Will the critical switch make gold shine – or dull?
Three Important Legacies of Yellen’s Fed Tenure
A crucial change is behind us. Powell is the new boss. Yellen is out. For better or worse, she doesn’t serve as the Fed Chair any longer. Although economists rated Yellen’s tenure very highly, President Trump didn’t renominate her for the position. Rightly or not? We don’t care. Let journalists debate endlessly – we will analyze the crucial Yellen’s imprints on the Fed, which could affect the gold market in the future.
First, Yellen focused mostly on the labor market, not without some successes. We don’t attribute it solely to her, but the unemployment rate fell from 6.7 to 4.1 percent under her tenure. As a reminder, the Fed has a dual mandate: maximum employment and stable prices. Although many Fed officials used to worry about high inflation, she was different. Yellen didn’t fear the uptick in inflation as long as there was a slack in the labor market. She, thus, believed that ultra low interest rates could and should stay near zero for far longer than previously thought to combat unemployment. Yellen hiked them not earlier than in December 2015. Since then, she gradually raised them to the range of 1.25 percent to 1.5 percent, which is still very low. The gradual tightening was positive for gold, which would have likely struggled more, had monetary policy been more aggressive. If Jerome Powell continues this cautious policy, gold may shine, despite rising interest rates.
Second, Yellen managed to start the unwinding of the Fed’s massive balance sheet, without triggering stock market turmoil. After unconventional actions of Bernanke, she had to get back to normal monetary policy, but not too fast. She definitely succeeded. If anything, the Fed is behind the curve. This is why gold wasn’t strongly hit by the Fed’s tightening. The U.S. central bank raised interest rates a few times, but the financial conditions remained easy.
Third, Yellen mastered communication with the public. She held quarterly news conferences and smoothly telegraphed the Fed’s moves well in advance. Thanks to well-planned expectations guidance, Yellen – contrary to Bernanke who triggered a taper tantrum by his unexpected remarks in 2013 – avoided any major stumbles. The clear communication transformed gold’s reaction function. The yellow metal now reacts more to the changes in the rate hike expectations than to real monetary policy decisions. Sell the rumor, buy the fact – as one can see in the chart below.
Chart 1: Gold prices under Yellen’s Fed tenure
Jerome Powell – Great Continuator or Game Changer?
Jerome Powell is now the new Fed Chair. Analysts expect that he will continue Yellen’s stance. But will he? How you play depends on your opponent. Yellen faced a sluggish recovery. But Powell sees tax cuts, higher economic growth, very low unemployment and perhaps finally rising wages. He will have to deal with the accelerating inflation, so Powell could move faster on normalization. Actually, such a scenario scared some investors last week into deciding to sell their equities. As people weren’t sure what to expect of Powell, good economic data turned out once again to be bad news for the financial markets. Surprisingly strong payrolls make traders to worry that the Fed will tighten its stance more. Hence, unless Powell convinces the markets that he will continue Yellen’s gradual approach, gold may react paradoxically for a safe-haven: decline on bad news and rise on good news.
But will he intervene to calm the financial markets? We don’t bet on that. Greenspan cut interest rates after the stock market declined 35 percent in the three months after he became the Fed Chair, but the current downturn is much smaller. Actually, we have seen some rebound since Friday. Another paradox: the correction in stock prices may help Powell in doing his job, because lower equity prices could relieve concerns about the formation of dangerous asset bubbles.
The conclusion is clear: although the latest declines were a tough welcome for Powell, they may actually be helpful for him. He is expected to continue Yellen’s policy. It is generally true, but economic conditions changed as well as the composition of the FOMC in 2018. It is now more hawkish than last year.
Given these developments, the shift from Yellen to Powell may importantly strengthen the hawks among the Fed. Hence, unless the correction evolves into turmoil, we still expect three (or even four) hikes this year. Indeed, according to CME data, the Fed remains on track to lift the federal funds rate in March. The market odds of a hike are above 75 percent. Higher interest rates should theoretically be negative for gold. But the usual link seems to be broken now. The part of the answer is the U.S. dollar. Another issue is that we are in the late stages of the economic cycle – as the cycle matures, volatility increases and investors start to buy more gold as a hedge. – Arkadiusz Sieron
Reaction to the Market Panic by Gold
Bullion Exchanges – Last week’s news was largely focused on the record lows reached by the stock market and the overall volatility it experienced over the past two weeks. Historically, during times of a struggling stock market, gold experiences a boost. This past week, however, gold did not increase, even while the stock market fell from its peak by more than 11%. A lot of points factor into the prices of precious metals, but our focus today is on one in particular: the forward-looking of markets.
To explain this, we should first discuss the base facts: since the high of 2872 reached by the stock market on January 29th for the SP Index, the broad market has fallen to 2532, a decrease of more than 11%, before undergoing a mild rebound on Friday. Throughout this time period, gold decreased by approximately 2.5%. In the next few weeks, we will cover the actions of silver during this timeframe, but for now, our focus will be gold.
The question today is this: at such an important moment, did gold fail?
The Foresight of Markets
Our theme today is the forward-looking of markets, the fact that they can both foresee and respond to events that have not yet occurred. Therefore, it is not surprising for the market to move against the tide that is expected of it.
An example of this is the movement of these same asset classes since the low in metals that have occurred since December:
Looking at a wider time period shows us that gold has actually maintained its value well in comparison to the stock market as a whole.
One possibility that we could consider with this information is that some investors, predicting that the broad market was headed for a steep decline, were moving the profits made from their stocks into precious metals.
Using Gold as a Form of Insurance
Looking at insurance as an example provides further basis for our theme that markets are forward-looking. A homeowner does not purchase insurance after they see flames in their windows, or car insurance in the moments following a car accident. Like this, one job that gold does is acting as wealth insurance, in that investors who have made a profit from other assets and are forward-looking will purchase gold when times are good, or in keeping with our metaphor, before the car accident has occurred, before the flames, when it is not yet needed.
Knowing this, consider that if gold increased before the fall, what can we imagine would happen during the crash itself?
Like insurance, people may have to cash-in their policy at the time of an accident. In this situation, this cashing-in shows up in the form of a mild decline happening at the same time as that of the stock market. An investor who used gold as an insurance policy these past months will have suffered fewer losses than one who kept their full investments in the stocks. Gold did the job that it was intended to do here, by significantly protecting the profits earned by that investor who was forward-looking.
Of course, there is no perfect insurance policy. Sometimes premiums are taken and never recouped, others the policy does not completely cover the losses, but one thing is true: some insurance is always better than none at all.
Consider the benefits of a wealth insurance policy before it becomes necessary. Perhaps the recent stock market crash was an isolated event, but perhaps it is simply a tremor before the real crash starts. It is impossible to know for sure, but knowing your options, like wealth insurance, allows you to make the best decisions going forward while the stock market recovers.
It is our strong recommendation that every investor regularly accumulate physical gold as a means of insurance.
The Popularity of Insurance
Not even 1% of Americans today own any gold at all. Less than 1% use physical gold as wealth insurance. What if that number were to double and 2% of the American people did? Or it grew to 10%? This is something that we plan to more fully explore in a future post, but if demand for a finite insurance policy like this one ever grew to such a number, gold’s value would be pushed higher by a multiple of today’s prices.
However, speculation and insurance belong in separate categories. The final note we leave you with today is that every investor should have gold as insurance, most importantly when they least expect that it is necessary.
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