Fed Rate Hikes - The Best Algorithm For Predicting Gold Upside

As nearly the whole world knows, higher interest rates are gold investing's worst enemy. As Warren Buffett has explained, gold is something where we pay to dig it up, we pay to put it away, we pay people to stand around and guard it, and all the while it produces no goods, pays us no dividend or gives us any interest. Well, Warren, if you take the trouble to closely examine the history of Federal Reserve raises in interest rates and gold, you got some more 'splainin to do!

If you look at what happened in the 1970's gold bull market, you see that the more gold had to compete with interest bearing investment, the better it did. In fact, there was a very close, positive correlation between the two:



These were the most extreme US interest rates of all time running to well over 10% and dwarfing our current numbers. Yet they did not kill the gold bull back then. Indeed, they seemingly waved a red cape in its face.

The 70s rate cycle was not an isolated case in its correlation with gold.  Adam Hamilton presents a detailed history of this in his article this week. He notes:

Before today’s rate-hike cycle was born in mid-December 2015, the Fed had executed fully 11 rate-hike cycles since 1971. Those are defined as 3 or more consecutive FFR increases by the FOMC with no interrupting decreases. Our current rate-hike cycle to which the Fed added a fourth hike this week is the 12th of the modern era, certainly nothing new. So there’s a substantial rate-hike dataset to evaluate gold’s action.

He notes that the average reaction of gold during all 11 previous rate ramp-ups is a climb of 27% including the most recent cycle (2004 - 2006) where rates were aggressively quintupled and gold reacted with a 50% climb over that time. If you are an investor with the mindset that rising rates is a reason to sell or avoid gold, you need to read Adam's article. He points out that our present rate hike cycle is playing out as in the past:

If you look at the four rate raises so far in our current cycle, we see that you are hard pressed to find a guru or algo that predicts gold climbs any better. If you were a newsletter with this track record, you could sell a zillion subscriptions. Note that the arrows all fall on an ascending trend since the first one in late 2015. As the above chart shows, there is typically a decline in gold leading into a much talked about FOMC meeting where everyone has come to expect a rate increase. This weakness also lasts a couple weeks or so after the fact, then a vigorous climb ensues.

Because we have just had a rate increase June 14, that would schedule our current gold weakness into July, which also agrees with many wave counters and technical analysts who are saying July/August is going to be a major bottom. It also agrees with the simple up-trending channel in the above chart that would put a visit to the bottom at about $1220-$1240, probably in July/August. It also agrees quite nicely with my fractal argument presented here. But these rate hikes can also send gold straight into a tizzy as it did the last time in March. So waiting for a bottom could leave you chasing any new exposure you want.

But why would gold, with no interest return and even a cost of storage for physical ownership, behave in such a counter-intuitive way? Is this just to punish investors who try to think logically, Mr. Market's specialty? Hamilton makes the point that these rate changes are well telegraphed. The Fed doesn't like to roil markets, so they don't like to move unless at least 70% in the polling expect them to. So you could have a longer term fundamental working in the background pressuring gold higher while the buy-the-rumor-sell-the-news effect works in the short-term around the Fed meetings.

What could that longer term fundamental be? Well, I don't really know with any certainty. But I suspect it is the age old thing about gold being an alternative currency. Fed rate raising cycles always come after they have done some kind of financial rigging, and that always somehow lessens the soundness of the dollar. It also undermines the natural viability of the economy.

As I discussed in "Fractal And Fundamental Gurus Agreeing On A Gold Mega-Bull" gold has a long history of going into bull phases, along with the stock market, years ahead of some calamity involving dollars in the bank. This was true in the 1920s when the banks were the problem, it was true in the 1960s when a gold decoupling with the dollar and double digit inflation approaching made the dollars the problem. And it is probably true now with some kind of dollars-in-the-bank problem approaching.

You can only speculate on what the gold market may be seeing. But with the European banks on shaky ground and linked to all banks no matter how healthy, you could say it's the banks. And with the dollar's soundness continuing its decay as the world's reserve currency, you could say it's the dollars. There are plenty of problems to choose from. Let's hope the problems are fixed before they get here. But a gold hedge would be in order in the mean time.