The Key Factors Driving Gold: Part 1

GAVIN WENDT: Gold continues to defy the skeptics, demonstrating robust price support as we’ve previously advocated around the $1,200 per ounce mark.

A host of positive factors are driving gold’s resilience – and most of them aren’t new.

US Interest Rate Speculation

Speculation regarding the US Federal Reserve’s potential moves on interest rates is the biggest game in town – and has been for some time now.

Over the past couple of years the Fed has tried to talk tough with respect to interest rates, admitting it recognises the dangers of keeping rates too low for too long.

At the same time it points to economic growth in the US as clear evidence that its ‘easy money’ policies are working.

But the ongoing problem is that whilst the Fed is prepared to talk the talk, it seemingly isn’t prepared to follow through, with rate rises in a perpetual state of deferral.

What the situation underlines is the fragility of the US economic recovery – something the Fed won’t directly admit for fear of spooking markets.

The Fed’s easy money policies have distorted market prices and encouraged destabilizing financial speculation – as well as unfairly punishing savers.

Even more importantly, the US economy and financial markets have become so heavily dependent on artificially-suppressed interest rates that it is extremely difficult for the Fed to wean markets off low rates without major repercussions.

The danger of course is that the situation won’t be reversed in time, resulting in dangerous potential consequences.

Unfortunately, the Fed has a well-established tendency of not recognizing the consequences of loose monetary policy, nor tightening, until it’s far too late.

Now let’s turn our attention to the issue of a potentially rising interest rate environment (when it eventually happens), as there is quite a bit of ignorance around the topic.

There are firstly many doubters whose firm belief is that a rising US interest rate environment is bad for gold – when in fact, the opposite is true.

The ultimate and real driver of the price of gold is a negative real interest rate environment, which is defined by nominal interest rates minus inflation.

In the real world, central bank policies of inducing negative real rates in order to ‘incentivise’ borrowing have had the effect of expanding the money supply and devaluing currencies.

We have seen this happen since the GFC, with virtually all major currencies declining substantially in value. Debt is inherently inflationary if you have the ability to print your own currency.

If we refer back to the period of significant commensurate interest rate and gold price increases during the 1970s, the gold bull market of the 1970s was dominated by inflation – interest rates rose steadily to keep up with it, but real interest rates were mostly negative for the entire period.

Indeed, the embryo of the gold bull market was formed back in the days of real interest rates and coincided with the commencement of a huge imbalance in key global economic factors, particularly in the USA.

Importantly, many of those same economic factors have failed to improve.

Rock-bottom interest rates have forced older savers as well as others to take risks with their money in search of decent returns.

This greater risk-taking has manifested itself in the form of US share and property bubbles, incentivized by the zero-interest rate environment and the Fed’s easy money policies generally.

The key is that the latest economic statistics do not support an early interest rates rise.

The US Federal Reserve has admitted that the American economy has lost juice, with the latest data revealing March quarter growth of just 0.2 per cent.

The combination of the lower-than-expected GDP figures and the Fed statement, has led to markets lengthening the timeframe of any interest rate move – something we have been skeptical anyhow about for some time.

Ultimately, the Fed will likely have to raise interest rates, probably as a litmus test to see how the market reacts, but we anticipate no negative impact on the price of gold.

Don’t miss Part 2 of Gavin’s look at What’s Driving Gold next week.

Gavin Wendt is the founder of MineLife, publisher of the MineLife Weekly Resource Report

 

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