SEMI-MONTHLY MONETARY UPDATE – GOLD “CONSOLIDATES” AS INVESTORS FEAR INTEREST RATE HIKE – “PLAY IT AGAIN, SAM!” (Woody Allen reference to Ingrid Bergman in 1942 film, “Casablanca”)

The capital markets, and gold related securities are fluctuating again, just as they did several months ago, with a pending interest rate hike (25 bp, big deal!). It is not the order of magnitude of the increase that investors fear, but the symbolic “direction”, possibly leading to more interest rate hikes in the future. This traditionally means lower prices for most asset classes, as investors require higher dividend and interest yields to compete with higher interest rates on the lowest risk government backed securities.

We continue to feel that interest rates will not rise materially. The debt, around the world, is too large and higher interest rates on newly issued paper would choke respective national budgets. Also, as far as the US rates, the export portion of our economy cannot afford the higher dollar which would result from higher rates. Our economy is barely running at a positive rate, in spite of near zero rates and trillions of monetary stimulus. This is supported just this morning with weak retail sales numbers from August, and the recently reported turndown in auto sales, in spite of heavy discounting. A higher Fed Funds Rate would accomplish only one thing. It would give the Fed room to come back down when the economy weakens further, which would be impossible from today’s rates already near zero. Rates will go up one day, but it will not be at the Fed’s choosing. They will have lost total control at that point, and the long term de-leveraging process will be entering its inevitable crisis stage.

As far as Gold is concerned, investors should understand that most investors consider higher interest rates negative for Gold, since gold ownership brings no dividend or interest. Minimal interest rates therefore allow Gold to be competitive in this regard, and right now the $13 trillion of negative yielding worldwide sovereign debt, and trillions more at negligible rates, allows Gold to be relatively attractive. Gold ownership allows investors to get all their money back in the future, rather than be guaranteed to get less than invested with a negative yield. This reality however, doesn’t get fully considered, as investors automatically sell almost all asset classes when an interest rate rise is expected.

Also relative to Gold’s presumed risk if rates go up, this is an inaccurate “myth” in any case. Gold’s performance depends on lots of other monetary and fiscal factors, such as prevailed from June, 2004 to June of 2006 when Gold increased in price from $390 to $630, up 62%. It so happens that Alan Greenspan raised interest rates by 25 basis points seventeen times. It also happens that the US deficit was “consolidating” after coping with Y2K, the dotcom crash and 9/11, before rising sharply to finance two wars later in the decade. More recently, the last time we had an actual rate rise, 25 basis points in December, 2015, precious metal securities bottomed almost precisely with the rate rise, and had a strong five months immediately thereafter. In the second half of May’16, gold investors feared a rate rise and in this case, when it did not materialize, Gold went straight up in June. Equity markets, in general, reacted similarly, both in January, and June, in the first case after an actual increase in rates, and in June after it was a false alarm.

So, “Play It Again, Sam”. Earlier this week, the US operating deficit for August was announced, a cool $107 billion, on the way to about $600 billion for the fiscal year ending September ‘16, and expected to continue rising.  We don’t know whether rates will be increased in September or not, but the market is reacting as it did in December and May. We suspect (can never be sure, of course) that the price of Gold will act just fine in very late September and/or October, whether a rate increase in announced or not.