We think much of the interpretations by the media and analysts of the U.S. Federal Reserve’s latest statements about the likely economic fallout, as the world’s largest economy starts to recover from the COVID-19 virus pandemic are far from accurate. That is, if the latest, much lower pandemic infection data does not represent a false dawn – which they well may, given the apparent enhanced spreadability of the new Delta virus strain.
Can the pandemic really explain the drop in precious metals?
At the meeting itself, there were no major changes in the ultra-low interest rate policy, which was coupled with significant quantitative easing (QE), that were implemented. It was speculated that the Fed might consider raising interest rates earlier than previous forecasts had specified but still probably not until 2023. With 2023 being two years on the horizon – a time frame of infinite proportions in economic terms leaves a huge opportunity for conditions to change for the better or worse. Who knows? The Fed’s market forecasting performance in the past has certainly not given us much confidence in its forward market projections.
Will there be increases to interest rates by 2023?
Nevertheless, the markets’ knee-jerk reactions to the latest Fed forecasting efforts – which suggest there might be interest rate rises implemented by 2023 – were followed by gold being marked down by $100 or so almost immediately, or even slightly ahead of Fed Chair Powell’s post-FOMC meeting statement hitting the wires, all while equities took a bit longer to sell-off, with the Dow ending down over 500 points on Friday. The principal beneficiary was the U.S. dollar index, which rose by more than two points. That, however, is very much a double-edged sword, as the rise will undoubtedly make global goods export prices to the U.S. even more competitive which will show up in yet another big balance-of-payments deficit as the figures filter through. Indeed, it was the dollar’s strong performance that may well have been the prime driver of the fall in both precious metals and equities.
Let's Get this Right
We were extremely pleased to see that that most realistic of gold commentators, Martin Murenbeeld of the Canadian economic consultancy that bears his name, almost wholly agrees with our take on the market’s reaction to the FOMC news interpretation. In the consultancy’s latest Gold Monitor newsletter, Murenbeeld comments,
“Let’s get this right: this week the Fed changed its collective outlook for year-end 2023; the nominal FF-rate projection (a weighted average of 18 FOMC participant projections) rose to 0.82% for year-end 2023, from 0.53% in March – a whole 29 basis-points! Understand, this is for the 2023 year-end, we are currently nearly halfway through 2021; year-end 2023 is 2.5 years from now. And that 29-basis point rise from March to June for year-end 2023 tanked gold by $100! Unbelievable!!”
It can’t be too often that a renowned economist like Martin Murenbeeld and a mere mining engineer like myself are in almost total agreement on economic matters – economic theory meets economic pragmatism!
Economic Theory Meets Economic Pragmatism
Another point with which we are in full agreement, and one that we emphasized at the end of last week. Murenbeeld goes on to note,
“the fact is, no one knows what the Fed will do between now and 2023, including the Fed itself. These are very unusual times; no one has experience with an economy recovering from a pandemic-induced shutdown... Need we say that we think the gold market, and the dollar market, has grossly overreacted?”
One needs to keep in mind that the Fed’s oft-stated priority is to return the U.S. unemployment to pre-pandemic levels, which is a ways away. The Fed firmly believes that the best policy to follow to achieve this goal is to continue with its easy and low-cost money initiative, and if this leads to increased inflation, which it is already doing, then so be it.
Murenbeeld’s slightly gloomy conclusions for gold investors on the latest gold price action are as follows,“The gold market fell into a hole this week on the back of a strong dollar and (in our view) a misinterpretation of what the Fed has signaled with its dot plots. To repeat, the Fed will be keeping interest rates well below inflation right out through 2023, regardless of the possibility, it may raise the FF-rate somewhat earlier than the market had interpreted. In our view, the Fed remains in a lower for longer mode, but on this, we clearly seem to be at odds with the market. It could take some time, we expect before the gold market sees it our way.”
We do disagree slightly here.
We feel that once the precious metals markets digest the fact that, for the moment at least, the Fed has stated it will keep interest rates at ultralow levels and QE in place for the foreseeable future, metals prices will likely experience a quicker recovery than Murenbeeld seems to be suggesting. However, if data continues to indicate that inflation is still rising and is maybe even getting out of control, as the doom-mongers continue to tell us, there will be those out there who may be convinced that the Fed will start hiking rates sooner rather than later. We suspect not, and we think that the Fed will continue to follow a patient approach.
Indeed, the Fed may actually be welcoming the current rising inflationary trends. It has been undershooting its average inflation target for many months, so a period of higher inflation to bring the average up to its planned level may be welcomed. Indeed, in some opinions, including Murenbeeld’s, a higher level of inflation is just what is required to eventually help bring down the record-high debt-to-GDP ratio in the U.S. and elsewhere.
If, however, the Fed is seen to be correct in its repeated proclamation that the rise currently being seen in inflation is indeed only “transitory” (one of the Fed’s current buzzwords), then the precious metals recovery could well be quicker, and stronger than many market analysts expect. We certainly believe that there is no need for the gold investor to panic and sell off as of now.