Gold’s deep new
secular lows of recent weeks were fueled by American futures
speculators’ overpowering fear of Fed rate hikes. They believe
zero-yielding gold is doomed in a higher-rate world, so they dumped
gold futures at astounding record rates. The problem is history
proves just the opposite, that gold tends to thrive during
Fed-rate-hike cycles. This revelation is a super-bullish near-term
omen for gold.
Some brief context
is essential to frame gold’s apparently dire predicament today.
Late July saw gold crushed to new secular lows by a record extreme
gold-futures
shorting attack brazenly executed to blast through long-side
stops and foment panic selling. But this burst selling soon
fizzled, leading to a major gold bottom in early August. Over the
subsequent few months, gold carved an impressive new uptrend.
By the middle of
the day on October 28th, gold had climbed all the way back up near
$1182 which was 9.0% above its artificial early-August low. But
that very day the Federal Reserve’s Federal Open Market Committee
that makes monetary policy threw the markets an unexpected curve
ball. The FOMC inserted a surprise statement sentence warning
“whether it will be appropriate to raise the target range at its
next meeting”.
This shocked
traders, as it was the first time the Fed made a direct reference to
a possible imminent rate hike since it first implemented its
zero-interest-rate policy ages ago in December 2008. This catalyzed
the already-bearish American gold-futures speculators into selling
with reckless abandon. Starting that very day, gold would fall for
14 of the next 15 trading days for an 8.4% total loss in just
several weeks.
This gold-futures
selling was off-the-charts astounding, occurring at extreme record
rates far beyond anything ever witnessed before. That span since
the Fed’s hawkish late-October surprise saw the most single-week
speculator gold-futures short selling ever by huge margins.
Multiple-week records of gold-futures selling by this same group of
traders were also shattered, as explored in depth in
my essay last
week.
American futures
speculators wreaked havoc on gold since that last FOMC meeting
because they are utterly convinced the coming Fed-rate-hike cycle
will devastate gold. Their thesis sounds logical on the surface.
Gold yields absolutely nothing, so as rising rates force yields on
bonds higher investors will abandon gold to migrate into bonds. The
higher prevailing interest rates, the less attractive gold will be.
Nearly all traders
take this rate-hikes-will-doom-gold outlook as gospel today. But it
is fatally flawed on a blindingly-obvious front. Gold has always
yielded zero, yet it still powered higher in gargantuan secular
bulls. Between January 1970 and January 1980, gold skyrocketed
2332% higher! Over that exact span the benchmark federal-funds
interest rate the Fed targets averaged 7.1%, compared to zilch for
gold.
Then between April
2001 and August 2011, gold soared 640% higher. Despite the advent
of ZIRP back in late 2008, the FFR still averaged 2.1% during that
span. With gold enjoying gargantuan secular bulls that greatly
multiplied investors’ wealth in far-higher interest-rate
environments than today’s, it is readily apparent gold isn’t valued
as a yield play. That whole idea is utterly nonsensical for
an asset paying no cash.
Because it yields
nothing, gold is often derided as a “sterile investment”. But that
is rather ironic since that definition includes all stocks that
don’t pay dividends. Saying gold is doomed in this next
Fed-rate-hike cycle is as silly as claiming wildly-popular
zero-yielding stocks like Facebook, Amazon, Netflix, and the
company formerly known as Google will be obliterated as investors
flee them to buy higher-yielding bonds!
Investors have
flocked to gold for millennia for the same reason they buy stocks,
because they want to buy low to later sell high as demand grows.
American futures speculators’ contention that sterile gold is
somehow a yield play is utterly absurd, both historically and
logically. Gold is similar to any stock that doesn’t pay dividends
from an investment perspective, a price-appreciation play
where yields are irrelevant.
American futures
speculators are so whipped up into their groupthink gold-to-zero
hyper-bearish frenzy that they can’t see this truth. The gold-price
impact of their resulting extreme record gold-futures selling has
been so dire that investors have fallen into this same mental trap.
But the prudent investors and speculators transcend herd emotions to
study how gold actually performed during historical Fed-rate-hike
cycles.
Last summer I did
a comprehensive
study of this very question, the first I’ve come across. This
proved a quite-tedious project. I downloaded nearly a half-century
of daily federal-funds-rate data directly from the Fed itself, and
merged it into a gold-price spreadsheet. It turned out the FOMC has
changed its FFR target a whopping 251 times in the 45 years
since 1971. This aggressive frequency really surprised me.
Since the FOMC
meets 8 times per year to make monetary-policy decisions, that
equates to about 360 meetings over that span. And given the lack of
changes in the FFR since late 2008, it is hard to believe the FOMC
changed the FFR at well over 2/3rds of its meetings. But during
particularly-volatile market episodes the FOMC calls emergency
unscheduled meetings, which tend to result in panicked rate cuts.
With the Fed’s
first rate hike in the 9.5 years since June 2006 universally
expected next week, it is the historic FFR increases we are
interested in. And futures speculators aren’t devastating gold only
because they fear a single quarter-point hike, but because they are
expecting a new Fed-rate-hike cycle. So I painstakingly
scoured the Fed’s historical FOMC statements and FFR data for
federal-funds rate hikes.
In order to be a
rate-hike cycle, multiple sequential hikes are required
without intervening FFR cuts. It turns out the FOMC has made 6 lone
rate hikes bracketed by cuts since 1971. There were an additional 6
more times the FFR target was raised twice back-to-back before it
was reduced again. There’s no way one or two isolated hikes make a
Fed-rate-hike cycle. It’s amazing how much the Fed has vacillated
on rates!
The most generous
definition possible for a Fed-rate-hike cycle is 3 or more
consecutive FFR increases with no interrupting decreases. By
this conservative metric, the FOMC has executed fully 11 rate-hike
cycles since 1971. Gold’s actual performance within these
historical cycles, starting and ending on the exact days of their
first and last hikes, is critical for understanding its likely
performance in this coming cycle.
These charts
highlight every Fed-rate-hike cycle in modern history in light red.
They don’t always match the actual troughs and peaks in the
federal-funds rate perfectly because the Fed doesn’t directly
control the FFR. It is technically a free-market interest rate
determined by federal-funds supply and demand. That is where
commercial banks borrow and lend their cash deposits held at the Fed
on an overnight basis.
Instead the Fed
sets an FFR target, which it then attempts to achieve through
open-market operations where it directly buys and sells in the FFR
market. While the Fed has gotten more sophisticated over the years
in bullying the actual FFR to its target, there are still
deviations. Bending the free market to its will can literally take
tens of billions to hundreds of billions of dollars of trading, is
certainly isn’t a trivial task.
Finally a
half-dozen key data points are noted for each Fed-rate-hike cycle.
Starting at the top is the total increase in basis points,
hundredths of a percent. That is followed by the number of
individual hikes in each cycle, and their average basis-point
increases per hike and per month. Then comes the duration of each
Fed-rate-hike cycle in months, followed by gold’s price performance
over cycles’ exact spans.
Nearly a
half-century of data encompassing all possible market conditions
ranging from raging secular stock-market bulls to a full-on stock
panic is a hefty sample size. If American futures speculators’
fervent belief that zero-yielding gold gets killed during
Fed-rate-hike cycles is correct, it would absolutely show up
historically in such a massive data set. But it doesn’t, because
gold has obviously never been a yield play!
On average during
the exact spans of all 11 of the Fed’s rate-hike cycles of the
modern era, gold rallied 26.9% higher! That’s a serious gain
during events that are supposed to slaughter gold. A similar gold
upleg off its latest secular low driven by Fed-rate-hike fears would
carry this metal all the way back up near $1336. If I was a futures
speculator heavily short gold with extreme leverage, this would
terrify me.
Digging deeper,
the hard historical data proves Fed-rate-hike cycles are even more
bullish for gold. The majority 6 of these 11 cycles have seen gold
gains averaging a staggering 61.0%! Gold is more likely to
rally big during a Fed-rate-hike cycle than fall, contrary to
speculators’ self-fueled delusion today. And a merely similar gain
off gold’s latest secular low in the coming cycle would catapult it
vastly higher near $1695.
But in the
immortal words of legendary pitchman Billy Mays, but wait there’s
more! In the other 5 Fed-rate-hike cycles where gold lost ground,
its average loss was just 13.9%. Gold’s wins when the Fed is hiking
rates overpowered its losses in a very asymmetrical commanding
manner. There is simply no way the case can be made historically
that Fed-rate-hike cycles are exceedingly bearish for zero-yielding
gold.
It blows my mind
that American futures speculators refuse to see this hard truth.
These guys are making super-risky leveraged downside bets on gold
on a totally-false premise! Their record gold-futures short
selling since the FOMC’s hawkish surprise in late October is
happening at
extreme leverage of up to 28x, vastly greater than the
decades-old legal limit in the stock markets of 2x. The price for
being wrong is catastrophic.
At 28x leverage, a
mere 3.6% gold rally would wipe out 100% of the capital risked by
speculators in their recent extreme record shorting binge. Anything
beyond that would ignite a ruinous wave of margin calls where they
would lose far more money than originally bet. With so much capital
at stake that could be wiped out in a matter of hours if they
are wrong and gold rallies, you’d think they could study some
history.
This basic
research took me less than a day, not much time for futures
speculators to invest to protect their hard-earned wealth. And even
if they aren’t willing to look back 45 years, how about just the
last Fed-rate-hike cycle. That ran between June 2004 to June 2006,
and saw the Fed more than quintuple its federal-funds rate to
5.25% through 17 consecutive hikes totaling 425 basis points. Did
that slay gold?
Not so you’d
notice. Instead of spiraling into oblivion as speculators
universally assume will happen in this next rate-hike cycle, gold
powered 49.6% higher over that exact span! A similar gain off
gold’s latest secular low would blast it up to $1575. Clearly
Fed-rate-hike cycles in real-world history are nothing like the
insurmountable nemesis for gold that is wrongly assumed today. What
a steaming pile of crap.
With Fed-rate-hike
cycles actually overwhelmingly bullish for gold historically
contrary to the groupthink delusion today, let’s examine the factors
separating gold’s wins from losses. It turns out there are two
dominant ones, the gold levels where it enters Fed-rate-hike cycles
and the pace of their actual FFR hiking. Gold performs best when it
enters the rate-hike realm near lows and those hikes are gradual.
If you carefully
examine the 5 rate-hike cycles in these charts where gold lost
ground, in 4 of those the gold price was up near major secular
highs when those cycles began. Like anything in the markets,
gold can only be driven to lofty heights if investors like it and
have already deployed heavily into it. This leaves gold overbought
and technically vulnerable, overriding any other influencing factors
including rate hikes.
Obviously gold
isn’t entering this coming Fed-rate-hike cycle near major secular
highs, just the opposite is true. Just last week, the extreme
gold-futures selling by American speculators battered gold to a
major new 6.1-year secular low. Investors are
radically
underinvested in this essential portfolio diversifier now, and
it is universally despised. That means there is huge room for
capital to return as the Fed hikes rates.
The historical
record shown in these charts proves that gold’s biggest gains during
Fed-rate-hike cycles occur when it enters them near major secular
lows. So leading into the FOMC’s likely initial rate hike next
week, we have the best-possible gold-price setup. With gold so
darned low and speculators’ futures short selling so epically high,
a sell-the-rumor buy-the-fact scenario on the Fed’s hike is
highly likely.
The second major
driver of gold’s performance during Fed-rate-hike cycles is the
pace of those rate hikes. In the 6 rate-hike cycles since 1971
that saw average gold gains of 61.0%, the average
federal-funds-rate-target increase per hike and per month of these
rate-hike cycles were only 35 basis points and 24bp. Investment
capital flowed into gold most readily when the Fed was the most
gradual and measured.
In contrast,
during the other 5 rate-hike cycles that saw gold lose an average of
13.9%, the average FFR increase per hike and month were radically
higher at 110bp and 141bp! During times of extreme market
stress, the Fed tends to panic and get aggressive. The resulting
dislocations including massive bond losses tend to frighten
investors into cash instead of gold. This pace-of-hikes gold link
was very pronounced.
Overall the 11
Fed-rate-hike cycles since 1971 saw average per-hike and per-month
FFR increases of 69bp and 77bp. So gold thrived when the hiking
pace was well below this average, and slumped when it was well
above. And by this historical standard, the Fed’s next rate-hike
cycle couldn’t possibly look any more bullish for gold. The uber-dovish
Yellen Fed has all but promised it will be the most gradual ever.
Just last week,
Janet Yellen gave a speech in Washington where she said the FOMC is
not planning to use its normal rate-hike-cycle strategy of hiking at
every meeting. That’s what it did in its last one in the mid-2000s,
17 consecutive hikes in 17 consecutive FOMC meetings. Yellen drove
home her gradualist approach on the hiking pace saying, “This may
turn out to be a very different cycle than past cycles.”
Federal-funds
futures traders, the best in the world at handicapping the vagaries
of central-bank action, currently believe the FOMC will hike next
week and 2 to 4 times in 2016. And they expect the hikes to be just
25 basis points each. So we are looking at 9 FOMC meetings
including next week’s over 12 months, and a total FFR increase
between 75bp to 125bp. We can average this to a 100bp midpoint for
illustration.
If the Fed hikes
by 100bp over the next year, which most traders think is far too
aggressive to happen, we are looking at a pace of hikes averaging
just 11bp per FOMC meeting or 8bp per month. That would easily be
the slowest Fed-rate-hike-cycle pace of modern times, and almost
certainly the entire 102-year history of the Federal Reserve.
Remember the more gradual the rate hikes, the more gold tends to
power higher!
So with gold near
major secular lows heading into this imminent Fed-rate-hike cycle,
and that cycle itself likely to be the most gradual ever witnessed
by far, gold is overwhelmingly likely to power dramatically
higher as the Fed hikes rates. That’s what gold’s done in
rising-rate environments historically, so that’s what gold is almost
certain to do again regardless of American futures speculators’
delusions on this.
And that leads to
a final important question. Why do investors return to
zero-yielding gold when rates are rising? The answer is simple.
Rising rates are far more damaging to overvalued stock and bond
markets than gold. Rising rates create direct losses on
existing bonds’ principal as those outstanding bonds are sold in the
marketplace to reflect higher prevailing yields. So some bond
investors flee to gold.
So do stock
investors as rising rates hit
overvalued stock
markets on multiple fronts. They increase debt-service costs
throughout the economy, leaving less money to spend which erodes
corporate sales. This forces earnings lower, increasing
valuations. Higher borrowing costs also curtail the debt-financed
corporate stock
buybacks that boost earnings per share, which have been
incredibly high during the ZIRP years.
Gold is really
unique in that it is a true alternative investment that moves
contrary to stock markets. So it tends to fare the best, enjoy
relentlessly-growing investment demand, when stock markets are
suffering. And boy do Fed-rate-hike cycles wreak havoc on stocks,
especially when they enter the cycles up near secular highs at
overvalued levels like today. So this next Fed-rate-hike cycle
looks super-bullish for gold prices.
Investors can
position for this coming Fed-rate-hike-cycle trend through
traditional physical gold bullion itself, or via the flagship GLD
SPDR Gold Shares gold ETF. But the greatest way to really multiply
wealth as gold inevitably returns to favor is in the left-for-dead
shares of its elite miners. They are now trading down at
fundamentally-absurd levels relative to their
existing profits,
which will soar as gold powers higher.
Gold stocks are
very likely to be the best-performing sector next year by
far, and you are going to kick yourself 6 months from now if you
ignored this incredible opportunity to buy them near extreme
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Fed’s rate hikes get underway.
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The bottom line is
contrary to American futures speculators’ fervent belief, gold
thrives during Fed-rate-hike cycles historically. Rising rates are
very damaging to conventional stocks and bonds, which leads
investors to return to counter-cyclical gold. The lower gold’s
price levels entering Fed-rate-hike cycles, and the more gradual
their hiking pace is, the better gold performs as the Fed forces
interest rates higher.
History
overwhelmingly proves this, with gold rallying in the majority of
Fed-rate-hike cycles to enjoy very large average gains. And given
the radical underinvestment in gold today and record extreme
gold-futures shorting by speculators on the false premise that Fed
rates hikes are gold’s nemesis, gold’s upleg in this next
Fed-rate-hike cycle should prove exceptionally large. Frenzied
short covering will initially fuel it.
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