FED, Gold, Silver, Interest rates and Markets 2016

Video transcript:

Today is Sunday 11th December 2016 and we are expressing our view on the forthcoming FED interest rate decision due on 14th December and its likely impact on gold and silver prices.

The overwhelming consensus in financial markets is that on 14th of December, interest rates will rise in the US by 0.25% to a target range of 0.5%-0.75%.

If we think back to the last time the FED raised rates, which was in December 2015, it forecast that 4 rate rises were likely to occur during 2016. Stock markets fell and the price of gold then began to rise from $1049 to $1274 within 3 months and peaked in July at $1370 while silver rose from approximately $13.58 to $17.85 by April, then peaking at $20.71 in early August; for it became clear that the 4, and then amended 2 interest rate rises, were not going to occur. Despite gold and silver prices now having fallen back somewhat, they are still some 11% and 25% higher than they were 12 months ago.

There are in our view 4 main reasons why the FED is likely to raise rates again this week:

1. The economy has created on average 188,000 new jobs per month since last year with the unemployment rate falling from 5% - 4.6% the lowest rate recorded since August 2007. Hawks argue that participation has reached its limit, so little slack remains in the labour market. Firms, large and small, list hiring difficulties among their top concerns and fewer workers were laid off or fired in September than in any month since data started being collected.

2. Wage and price inflation. Although hourly wages are only about 2.5% higher than a year ago, Researchers at the San Francisco Fed have suggested that a slew of retirements by baby-boomers on large salaries are dragging this average down. Without this anomaly, the median hourly pay rise is running at 3.9% - almost as generous as in 2007.

Although price inflation, is not as yet at the Fed’s 2% target level it is getting closer. Excluding food and energy, prices are 1.7% higher than a year ago, up from 1.4% at the end of 2015

3. Congress will probably cut taxes next year under a Trump Presidency. Higher rates may be needed to stop any fiscal stimulus becoming too inflationary.

4. To save face. For the FED to maintain at least some degree of integrity, it has to raise rates - to forecast 4 rises and actually produce none bodes ill of its economic forecasting, and too much emphasis has been made by Janet Yellen in recent weeks about this possibility for it now not to occur.
To support our view further, The CME FedWatch tool has interest rate markets pricing in a 97.2% chance of the FED funds target rate band increasing to 0.5 to 0.75%.

With a rate hike all but priced in, investors will be looking at the Fed's forward guidance, and if hawkish; because of uncertainty concerning the new Administrations policies, the European banking concerns and current record stock market levels, the risk for these markets is tilted to the downside. We suspect however that if the FED raises rates but offers a dovish tone, then markets may continue their upward trajectory, though to be frank, a small correction would in fact be healthy.

We should not forget that there are a number of key economic data releases in the U.S. this week, of which the FED is likely to have prior knowledge. On Wednesday the PPI report and retail sales figures for November are released. Retail sales are expected to continue their upwards trend with analysts expecting a rise of 0.5% month-on-month. On Thursday the inflation report is expected to show a modest uptick to 1.7% year-on-year, heading towards that 2% target the Federal Reserve has in its sights, and on Friday housing starts and building permits are reported.

Any surprise in these figures, could potentially cause the FED to delay a rise, however it is our strong view, and has been for 8 months, that rates will rise in December by 0.25%

So the question we know our listeners wish to have the answer to, is what does this all mean for markets, and in particular, for gold and silver prices?
Well according to an article published last Friday by Adrian Ash who runs the research desk at BullionVault, Gold prices rose more often on Fed interest-rate hikes than on cuts during the last 30 years.

In summary he argues 2 keys reasons:

1. Markets anticipate a rise in rates well in advance, and the price of gold, and often silver, falls prior to the rise because of the strengthening dollar and because the two metals offer zero dividend. This is often overdone, and so when the rise does occur, it’s all but priced in and prices begin to recover.

2. Gold prices rise after an interest rate hike because the reason the FED raises rates is usually in anticipation of rising inflation and gold traditionally performs better in a higher inflation rate environment.

Both of these reasons make sense, and collective wisdom should suggest that gold and silver will get a bump once the rate rise has been announced.
We however are a little more sceptical for the following reasons. Most of the Western world is actively embarked on a Quantitative Easing Programme, reducing the value of their currencies against the dollar. China too, with a mass exodus of the Yen or Renminbi out of China plus its economic policies are causing the Yen value to fall are witnessing funds being invested in the US Dollar instead.

We have seen the dollar index rise almost consistently from 85 in June 2014 to the 101 that it is today. In fact it has surpassed its last peak of 97 previously seen in March 2009, and seems to be heading in the direction of its previous peak seen in 2002 which stood at 113.

Now whilst we do not see 113 being reached again, certainly not easily, as it could prove harmful to the US economy, we would not be surprised to see a dollar index reach 105 and possibly 107. This does not bode well for gold and silver prices in US dollar terms. In other currency terms a different matter, but not in US dollars.

Our caveat however, as mentioned earlier is that much depends upon the FED’s forward guidance and tone and of course whether it raises rates in the first place which is, practically, a certainty.

So our view is somewhat contrary, in that there may indeed be a small bounce in gold and silver prices towards the end of next week and possibly a slight dip in stock market levels. However, caveat withstanding, we still see precious metal prices continuing to decline and the stock markets resume their rise– even though historic odds are against this from occurring.

Could we be wrong, absolutely, but our political antennae twitches that the current Administration wishes to see no collapse on its watch and that nothing but good economic news being forecast before the current President leaves Office. Just call us cynical!

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Illuminati Silver owners come from a background of Banking, International Wealth Management and Economics. Having now retired from these worlds we are not qualified to give investment advice. Therefore, this and other productions must not be deemed to be giving such advice and merely represent the personal views of its owners.