Gold Loves Rate Hikes!

Gold prices have bounced this week, with the yellow metal currently trading just over USD $1,330oz, up over 1.5% since last Friday. In Australian dollar terms, the yellow metal has pushed decisively through the AUD $1,700oz mark, currently trading at AUD $1,736oz, whilst silver is trading at AUD $21.50oz, with the local currency under pressure.

The biggest news of the week was of course the US Federal Reserve (Fed) rate hike, which the market had more than priced in ahead of time, with gold rallying in spite of the tighter policy conditions.

This continues a theme that we’ve seen in play since late 2015, when the Fed raised rates for the first time in nearly a decade, with gold often falling leading into a Fed meeting, then rallying afterwards.

You can see this clearly on the chart below, which my colleague @JohnFeeney10 produced.

The blue lines on the chart represent all the rate hikes (not including this week’s) that have taken place over the last two and a bit years, with gold rallying nearly every time the Fed has raised. The most obvious of those rallies were in early 2016 and early 2017, though gold has also performed very well since late last year as well, with the yellow metal up some 7% from its December lows.

The strong performance of gold over this entire rate hiking cycle (up 26% from the time of the first rate hike in December 2015) would no doubt come as a surprise to many financial market observers and investors, as zero yielding gold is always meant to struggle in environments where rates are moving higher.

However, market history demonstrates that what we are seeing right now is not an anomaly, and very much par for the course in rate hiking cycles. This was a subject we covered in our 2016 book “Gold for Australian Investors”, where we analysed the performance of gold in rate hiking cycles from the 1970s onwards.

That study found that three of the fastest periods of gold price appreciation (1971 to 1974, 1976 to 1980, and 2001 to 2007) occurred alongside significant tightening by the Fed.

Given the Fed at present plans to hike rates up toward the 3% mark and beyond by 2020 (see image below from this week), this would suggest we may be in for a continued period of strong gold price performance, particularly if these higher rates and/or political developments end up causing greater volatility in risk assets.

At the very least, given the above represents the expected path forward, it’s safe to say that the Fed will need to do quite a bit of tightening in the years ahead before it causes any major headwind for the precious metals sector.

Shorter-term, the gold market looks relatively well balanced, with some flows coming in via ETFs, whilst speculative money has eased back, with a March 18th update suggesting net longs in the futures market were at their lowest level in 10 weeks.

Trump Tariff Talk

Financial markets didn’t appreciate the latest rhetoric out of the White House regarding tariffs on Chinese imports, with the DOW down some 700 points. In early morning trade, the ASX is off nearly 100 points, or some 1.7%, as investors fear this will escalate into some kind of trade war.

Major miners are taking the brunt of this sell off, whilst the price of iron ore has been clobbered in recent weeks since tariff talk started in earnest, which has contributed to the pullback in the AUD we’ve seen recently.

The pain is being felt across Asia, with Japanese indices off over 2%, whilst Dow futures are suggesting the sell-off will continue for at least another day.

From our perspective, whilst we are generally against any kind of tariffs and definitely see this as hindering growth (no great insight there), we have no doubt a lot of this is just sabre-rattling in public, and that the Chinese and the Americans will sit down and negotiate, with the end result being that any package of tariffs that actually does get implemented won’t be as severe or as punitive as some may fear.

In the meantime though, the volatility that this brings to risk assets can’t help but provide some support for the precious metal sector, as investors seek a hedge and portfolio diversification.
Corporate tax cuts in the United States, and the likelihood of a blowout in the budget deficit to over USD $1 trillion (circa 5% of GDP) have also obviously stoked fears of inflation (see below), with is gold positive, whilst any weakness in the USD will also add some upside.

Stagflation Talk

This week JP Morgan released a note suggesting that the tax cut package in the United States could lead to a re-run of the 1970s stagflationary era, stating that; “we’ve never seen this type of stimulus so late in the economic cycle”, with the author stating current fiscal settings were similar to those on display in the 1960s.

Of course whether or not we do get a re-run of this era remains to be seen, but if history is any guide, physical gold and silver will be amongst the best assets to own should such an environment comes to pass.

From a portfolio perspective, the justifiable fears over higher inflation and/or stagflation should encourage all prudent investors to include an allocation to physical metals in their investment strategy.

Will Australia Follow the US Higher?

This week we saw the latest employment data released in Australia, which showed a jump in full time jobs, a reduction in part time jobs, and a slight uptick in the unemployment rate, which currently sits at 5.6%.

With global growth improving and the Fed hiking, market consensus is that the RBA is done cutting interest rates, and that the next move from Martin Place will be a rate hike.

For reasons we’ve explained many times over, we aren’t so sure, and indeed see the considerable softness in the local economy, and the lack of official inflation pressure as reasons for the RBA to cut, not hike, in the months ahead.

Note this outcome will almost certainly come to pass should recent weakness in the housing market continue, which was the central thesis of our just released research report “Australian Housing – End of the Boom?”, which included the chart below, showing how expensive residential housing is relative to gold.

Increasingly, it looks like more market participants are coming around to the view that the RBA won’t be hiking anytime soon, even if many other countries are.

As an article from Business Insider this week notes “The US Federal Reserve has hiked interest rates six times since late 2015, including an increase earlier this week. And interest rates in the neighbour to the north, Canada, have also increased three times in the past nine months. The Bank of England has also pushed rates higher, and could so again as early as May. Even the ECB, still purchasing tens of billions of bonds each and every month as part of its asset purchase program, also appears to be moving towards an increase in policy rates at some point next year. Everywhere you look, major central banks are on the way, or have already started, normalising interest rates. But not in Australia.”

Labour market conditions explain the difference. Even though underemployment and a lack of wage growth remain major problems in the United States, official statistics there look far better than they do in Australia, as the following chart highlights.

It’s not just the absolute number of underemployed people that is the problem in Australia, but also the trajectory of the underutilisation rate, which as you can see from the above chart, hasn’t improved at all in the nearly 10 years since the GFC hit.

In short – the employment data released this week does nothing to change our view that the RBA will either be on hold for a very, very long time, or cutting rates in the month ahead.

Until next time,
Jordan Eliseo

Disclaimer
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