Rate Hike Happened...Now What?

From The Maven Letter: March 21, 2018

So the new chairman of the Federal Reserve, Jerome Powell, did exactly what we all expected and bumped the benchmark interest rate up by 0.25% today.

Yes, higher rates are supposed to hurt gold, but traders always seem to overprice the hike in ahead of time. That means the news itself ends up being good for gold. The yellow metal has gained every time the Fed has raised rates since the tightening cycle started and today was no exception, with gold gaining 1.4% to reach US$1,334 per oz.

Powell didn’t say anything unexpected. He continued the commentary of slow and steady economic expansion and a tight labour market. Like Yellen did so many times, he noted that inflation is still running below the target of 2% and said he expects it to rise gradually towards that level.

The Fed increased its estimate for US growth to 2.7% this year, up from 2.5% in its December projection. It also boosted its 2019 target to 2.4% from 2.1% and suggested unemployment will continue to fall, slowly, reaching as low as 3.6% by the end of next year.

If that happens, darn straight will we see inflation.

Importantly, Powell stuck to the script of three rate hikes this year. He left a fourth potentially on the table, but his comments made it seem unlikely at this point.

In an equally ironic response, the US dollar slid on news of the rate hike. It was another example of how traders buy the rumour and then sell the actual news: the dollar lost almost 1% today, despite higher rates specifically supporting the greenback.

That’s the immediate impact. Taking a step back, what does it mean for the sector going forward? A few things.

First, gold has maintained a nice upwards trajectory for the last year or more, despite what is now four rate hikes. Meanwhile, the dollar has trended down consistently.

The reasons for that are several: competition from other currencies (ie a stronger Euro and Yen) encouraged forex traders to shift their bets elsewhere, inflation expectations limited expectations for the USD, and worries about trade wars introduced a risk factor that really moderated the Long Dollar trade.

Those factors are still in play – to different degrees one day to the next, sure, but in general. At the same time, risks are rising. Stock markets are more volatile, the dollar is not dominant, there are legion questions around demand for US Treasuries as the Fed reduces its balance sheet amidst a government that needs more debt to fund its budget, high yield debts are raising questions, and so on.

All those risks continue to encourage investment in gold. None are Stand Out Scary yet, which is why gold hasn’t made a major move. But investors are increasingly aware that risks are rising, which gives gold a very solid grounding.

However, all of that is happening amidst good, synced-up global growth. That growth is why the Fed can raise rates. And the more evidence we get of growth, the better base metals perform.

Higher copper, zinc, nickel, coal, and steel prices are boosting the share prices of base metal miners. Since the start of 2016 Vale is up %, Glencore is up 300%, BHP is up 35%, and Rio Tinto is up 46%. It’s basic math: higher metal prices mean they’re making more money.

The same hasn’t happened much with major gold miners yet, for two reasons. One, gold hasn’t gained anywhere near as much as zinc or copper. Two, investors don’t only invest in gold miners for finances; they usually also need to see rising risk pushing everyone to safe havens. That isn’t the case and so gold miners aren’t getting much attention yet.

It will happen. To be honest, I’m happy to wait a while. Another year or two of sentiment like we are currently seeing, with global growth amidst rising risk, would provide great opportunities to make money in base metals while doing fine in gold. The key will be to get out of everything other than gold before it all inevitably comes tumbling down…at which point gold will gets its day in the sun.

It takes time for a bull market and a period of global growth to peak and end, though along the way there are signs. Some of those signs are already evident. Take, for example, the following chart showing that the yield on the 2-Year Treasury just surpassed the dividend yield on the S&P 500.

The current bull market in stock began months after the yield on the 2-Year Note fell below that of equities, back in 2008. Nine years later, the ratio is reversing. Risk-adverse investors – who have been forced into equities whether they liked it or not during this epic bull market – will increasingly take note and move towards conventional safe havens, like Treasuries…and gold.

Seasonally, this is not the most exciting time for gold. The yellow metal tends to trend sideways to down from PDAC until late summer, with exceptions of course. Given how many unpredictables there are in the world right now, it’s possible we’ll see slew of exceptions. Tensions with Russia could ramp up, the Italian election could throw Europe into another round of disarray, Trump’s talks with Kim Jung-un could derail, tariffs and protectionism could ramp up, and stock markets could correct again.

Such events are all sufficiently possible that I’m not trading the seasonal moves this year. A few weeks ago, before PDAC, I used what seasonal strength there was to exit positions I no longer wanted to hold. However, I am not interested in selling stocks I like in order to buy them again at cheaper levels in mid-summer.

That opportunity could well play out; if it does I will add to positions. But there are enough possible gold catalysts and gold has shown enough sustained strength in the last year that I am not going to bank on things being a lot cheaper in a few months!

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