• Investors may be seriously misjudging the impact of QE3’s end
• Negative real interest rates may continue for years, sparking inflation
• The Fed could even inject more stimulus though a new QE programme
The Federal Reserve recently announced it has ended its monthly money creation and bond-buying programme known as quantitative easing. What will the Fed’s halt of bond purchases at the $4-trillion mark mean for precious metals markets?
The answer may be: not much.
Sure, gold and silver prices did fall after the Fed’s final taper. But the end of these monthly bond purchases now appears to have been fully priced into the markets.
The US Dollar Index rallied strongly from July through October – in part on euro weakness and relatively positive economic data in the US. Nominal strength in the dollar exerted downward pressure on the precious metals. Gold slumped and silver fell even more sharply.
Metals Markets Often Move Counter to Popular Expectations
It’s worth recalling what happened when QE3 was announced in September 2012. At the time, many analysts assumed that QE3 would provide an immediate boost to gold and silver prices. Instead, the metals markets responded counter-intuitively, declining for several months following the Fed’s announcement.
Fast forward to November 2014 and almost nobody expects the post-QE world to be bullish for precious metals. In fact, speculative interest in gold and silver sits at multi-year lows. Hedge funds are collectively showing one of their lowest net long positions in the silver market on record.
The Fed’s final termination of QE isn’t suddenly turning the hot money crowd even more bearish on metals. That crowd has already positioned itself on the short side.
At the same time, the end of new Fed bond purchases could spark a revolt against the US stock and bond markets, which have until now been floating on a rising sea of Fed liquidity. Previous cessations of Federal Reserve stimulus programmes have led to significant corrections in equity markets.
When the Fed Finally Hikes Rates, It Will Probably Be Chasing Inflation Higher
Of course, the Fed has no immediate plans to unload the more than $4 trillion in bonds it has accumulated on its balance sheet. Nor has it yet committed to raising its benchmark Federal funds rate, despite widespread expectations that it will do so by the end of 2015.
Fed chair Janet Yellen stated recently: “The appropriate path of policy, the timing and pace of interest rate increases ought to – and I believe will – respond to unfolding economic developments. If those were to prove faster than the committee expects, it would be logical to expect a more rapid increase in the Fed funds rate. But the opposite also holds true.”
In other words, if the economic numbers – especially those related to employment – turn ugly, the Fed might refrain from raising rates – or even introduce a new stimulus programme. Yellen has repeatedly indicated that stimulating job growth, as she sees it, takes precedence over fighting inflation.
That means the Federal Reserve may not raise rates until inflation begins spiralling out of control. In a Wall Street Journal survey of 30 economists, all but three expect the Fed to wait too long before raising short-term rates rather than move too soon.
In the months ahead, the financial media can be expected to speculate incessantly on the Fed’s next move and when it might come. Disciplined precious metals investors should ignore the Fed-gaming chatter and focus instead on what real interest rates are doing.
The Fed does not directly control whether long-term or even short-term rates are positive or negative in real terms. Negative real interest rates, which refer to rates that sit below the inflation rate, are generally bullish for precious metals. Negative real interest rates can persist or even become more deeply negative while the Fed is raising the short-term rate.
That is what happened during the great precious metals bull run of the late 1970s. The Fed was perpetually behind the curve on rate increases as inflation galloped higher.
Mike Gleason, a director at Money Metals Exchange, noted in a podcast earlier this year: “During the great gold and silver bull run of the late 1970s, the Fed wasn’t slashing rates. It was doing the opposite. The Fed kept raising rates, but it didn’t get out ahead of inflation until [then-Fed chairman] Paul Volcker stepped in and jacked rates up to punishing double-digit levels.”
Market Conditions Remain Favorable for Gold and Silver Accumulation
There is a widespread misconception that only rate cuts or more QE would be bullish for gold and silver. On the contrary, rising inflation pressures forcing the Fed to raise rates would potentially be quite bullish for gold and silver as well.
Instead of fearing rate hikes, metals investors should actually look forward to the next rate-raising cycle. That’s when the biggest gains in gold and silver could come.
At some point, real interest rates may turn positive and precious metals prices may get overextended to the upside. But neither situation exists under current market conditions.
This remains a favourable period for investors to accumulate physical precious metals while the herd isn’t paying attention.