Gold: What If The Fed Doesn’t Raise Rates?

Gold fell during trading on Thursday, as Fed Chair Janet Yellen continued to prevaricate over when the central bank will raise interest rates. The commodity subsequently hit a low of $1142.16 an ounce, as capital abandoned the precious metal for the Dollar.

The Fed’s outlook for an increase to the federal funds rate remains solid, however it should be noted that their dual mandate encourages them to only consider employment and inflation indicators. Although these metrics remain buoyant, there is some definite structural weakness in the broader US economy which begs the question, what if the wider economy fails to support a rate increase.

The reality is that the markets are strongly counting on a rate rise in 2015 and if this fails to eventuate, Gold will rise dramatically. Given that the majority of the western world is currently undertaking an easing bias, or experiencing lacklustre inflation, the concern is that this pattern will reach the shores of the US. Any deteriorating US domestic demand could lead to the Fed continuing to delay any form of monetary policy tightening.

Subsequently, the Fed’s Janet Yellen is playing a master game of “keep away” as she attempts to impact the markets expectations through statements that hint at eventual rate rises. However, Janet Yellen knows that any move to tighten monetary policy could potentially deflate the current equity bubble which has been supported not only by QE but also through a multitude of share buy-backs. Therefore, any move to raise rates can really only be supported by a broad range of stronger US economic indicators, not simply labour and inflation. Otherwise, the damage to a range of sectors could be quite marked.

The reality is that Gold is currently under- valued given the historical connection to the global M2-Money supply. The metal effectively decoupled from that metric in October of 2012 and has been in a bear trend ever since. However, in the long term, the world will return to normal inflation and gold should be expected to rally strongly.

In the medium term, the yellow metal is likely to continue basing around the $1140/ounce level but the real risk factor at play will be if and when the Fed raises rates. It would appear that the market has already substantially priced in the chance of a rate rise in the current gold price and therefore any failure to fulfil this expectation will cause a massive revaluation.

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Ultimately, I will state on the record that I do not believe that the Fed currently has an economic case to raise interest rates and that a weakening global market likely means that such a rise is improbable in 2015. Given Janet Yellen’s continual lack of timing and tone of her statements, it suggests to me that the status quo shall remain in place for the remainder of the year. However, one day soon, the market will wake up to the fact that they have been tricked…and then gold will soar!

Written By: Steven Knight