Gold Stays Strong Despite Rate Hikes, Inflation Pullback

gold-stays-strong-despite-rate-hikes,-inflation-pullback

With the news that year-on-year inflation declined slightly in July, markets seemed to take that as a sign that the worst is now over. Clearly the Federal Reserve’s rate hikes have been effective, and we have nothing more to worry about, or so markets believe. But reality may not be nearly as rosy.

Inflation remains at 8.5% year-on-year, still near 40-year highs. And the effective prices consumers have to pay at the grocery store, for cars, or for housing haven’t gotten any lower. Inflation is still going to be with us for some time to come, and a one-month respite during a month in which business activity is normally slower anyway due to vacationing is hardly grounds for rejoicing.

Against that backdrop it’s important to take a look at what gold is doing, as the yellow metal can often be a bellwether for what’s going on in the economy. And with gold shrugging off recent weakness to keep advancing, it seems that gold buyers don’t trust rosy prognostications for the future.

Rate Hikes and Gold

Conventional wisdom says that rising interest rates are supposed to be bad for the gold price. While that may or may not have been true at one time, it hasn’t been the case the past couple of times the Fed decided to hike the federal funds rate.

Gold’s weakness in recent months seems to have been twofold. First, hedge funds that stuck to that conventional wisdom offloaded their gold positions, putting downward pressure on the gold price. Secondly, but perhaps more importantly, gold was following a pattern that we saw in 2008.

What most people remember from the 2008 financial crisis and its aftermath was how well gold performed. But in the middle of that great performance came a period of time when even gold was losing value. In fact, from spring to fall of 2008 gold lost about 30% of its value, declining along with numerous other assets.

The explanation at the time was that institutional investors were rushing into cash or liquidating assets to come up with cash. And with gold being a highly liquid asset, it was one of the first ones liquidated to come up with quick money.

In fact, after gold’s drop in value in 2008 it turned around and started to gain value again, while the rest of the economy continued to falter. And even while markets struggled to regain their footing, gold continued to grow.

That’s why recent weakness in the gold market hasn’t worried longtime observers of precious metals markets. Over the long term, gold could continue to rise, as it has in recent weeks as it has shrugged off numerous headwinds. By this time next year, economic conditions will likely have changed, and the gold price could be much different than it is today.

Gold and Inflation

Gold is often trusted as a hedge against inflation. Its history of maintaining its value and purchasing power over time is well regarded by many people. And even though inflation dropped a little over the last few months, that doesn’t mean gold won’t continue to play a role as an inflation hedge in the future.

One of the obvious parallels to today is the stagflation of the 1970s, a period that was beset by high inflation, a weak economy, and real impediments to growth. Inflation wasn’t always high, either, but it fluctuated between about 6% and 11% for most of the decade.

That’s why celebrations of the pullback of inflation are incredibly premature. Even if inflation drops back to 5%, there’s no telling when it could begin to accelerate again, as the Fed’s actual ability to keep inflation under control is uncertain. For all we know, our current inflationary regime could end up looking like the 1970s all over again, with consistently high inflation putting upward pressure on prices throughout the economy.

Perhaps gold buyers are sensing this, as gold has rebounded from its recent lows and is once again threatening to push northward of $1,800 an ounce again. So despite the media hype about slightly lower inflation, gold markets don’t seem to view that as anything but a continued positive for the price of gold.

What About the Future?

Forecasting the future is notoriously difficult. And when it comes to markets and economic prognostications, it’s even more difficult.

In our present situation, that’s complicated by the fact that we have an 800-pound gorilla in the room, the Federal Reserve. The Fed has gotten markets addicted to easy money since 2008, so much so that we don’t even know what normally functioning markets look like anymore.

There are plenty of people midway through their careers on Wall Street who have only ever known an economy in which the Fed is actively trying to manage things through injections of money. So when those injections stop, these people aren’t going to know what to do and how to react.

We also don’t know how committed the Fed actually is to stopping its easy monetary policy. The last few times the Fed has tried to tighten things up, markets reacted negatively and the Fed cut its plans short.

So far markets seem to have shrugged off the Fed’s tightening, which has only just barely started. But if things start to get bad, and the economy starts to look like recession is imminent, will deteriorating markets force the Fed to change its tune and get back to easing?

It’s anyone’s guess, and things could literally change from week to week. That kind of regime uncertainty is not anything investors want to see. And for many people, that uncertainty about the future, the risk of recession, and the fear of another crisis is helping them decide to protect their assets with gold.

Gold performed spectacularly during the stagflation of the 1970s, with nominal annualized returns of over 30% over the course of the decade, and real annualized returns of over 20%. That made gold a rare bright light during an otherwise dismal decade.

If gold were to show similar performance this decade, it could brighten the outlook for many people who expect this decade to be one of stagnation and economic turmoil. Even if it were to show performance similar to that of the 2008 crisis, when it gained 25% while markets fell more than 50%, a lot of gold owners would be very happy.

While the future is impossible to predict, the continuing strong demand for gold and the increasing uncertainty about the direction of the US economy certainly seem to indicate that gold should continue to be a solid performer in the future. And whether you’re interested in a gold IRA to protect your retirement savings or just looking to sock away a few gold coins for a rainy day, Goldco can help you fulfill your gold buying needs.

With over $1 billion in precious metals placements and established relationships with mints, custodians, and depositories, not to mention thousands of satisfied customers, Goldco is one of the biggest and most trusted names in the precious metals industry. Call Goldco today to speak to one of our experts and find out more about how gold can help you safeguard your savings.

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About the Author: Trevor Gerszt