Federal Reserve's Soft Stance Should Boost Gold Prices

Release Date:  Thursday, March 21, 2019

Source: TheStree.com, By: Simon Constable, Updated: Mar 20, 2019 6:15 PM

Gold is set to surge as long as the Federal Reserve keeps a dovish tone to its policies, as it did on Wednesday when it signaled it would keep short-term interest rates at their current levels.

Historically, when the central bank pauses its cycle of increasing the cost of borrowing money, prices for the yellow metal tend to trend higher, according to a recent report.

"[...] after the Fed pauses, historical analysis suggests that gold eventually reacts positively as the pause cycle extends and/or the Fed eases monetary policy," states the March-dated World Gold Council Report.

In other words, as long as the Fed doesn't start increasing interest rates any time soon, then price gains are in the cards for gold.

Precious Metals Investors Prove Prescient

The price of gold has already rallied since mid-August, which was when precious metals investors started to get worried about softness in the U.S. economy. The yellow metal was recently trading at around $1,305 a troy ounce, up from $1,175 on August 15, according to data from Bloomberg… GDP growth in the U.S. hit a recent annualized peak of 4.2% in the second quarter of 2018 before steadily slowing to 2.6% in the fourth quarter, according to government data collated by statistics website Trading Economics.

Before that economic deceleration last year, investors widely anticipated that the Fed would hike rates as many as four times this year. However, that's not likely now because the outlook for the economy is weaker than previously expected. In January, Fed chairman Jerome Powell said the policy committee "will be patient," meaning that it won't aggressively pursue hikes in the cost of borrowing. At the same time, even the Fed, which is often optimistic about the health of the U.S. economy, doesn't see a resurgence of the peak growth seen last year, and neither do many other economists. The economy is expected to grow just 2.3% this year, according to a recent survey by CNBC.

That doesn't even take into account the chance of a recession.

"We think an imminent global recession will be averted, but its chances remain high at about 25%," states a recent report from French financial firm BNP Paribas. "In the event of [a] recession, the US Fed would be likely to slash rates."

Or put another way, if the U.S. economy contracts, the central bank would lower the cost of borrowing.

History Is a Good Gold Guide

The likely slower growth and the possibility of a recession mean that there is every reason for the Fed to continue to hold tight on raising interest rates, at least for the foreseeable future.

In turn, that means that gold prices should continue rising and outperforming other assets, according to the WGC report.

Historical post-tightening periods have shown an eventual strong gold performance, counterbalancing the performance of risk assets such as stocks or commodities, and complementing -- sometimes even outperforming -- assets such as Treasuries and corporate bonds.

In other words, once the monetary tightening (or period of increased borrowing costs) stops, then gold prices start to rise, and frequently they can rise faster than those of other assets.

The report does add that sometimes the results can take a while to manifest. But it is worth noting that gold prices jumped 7% in the one month following the end of the 2004-2007 rate hiking cycle, and by 18.8% in the 12 months after, according to the report.

Those returns compared to 4.4% and minus 16.5% for stocks over the same one and 12-month periods, respectively, the report states.

A similar thing happened at the end of the Fed's 1999-2001 tightening cycle. In the 12 months after that period, stocks fell 7.4% while gold prices gained 3.6%.

Or put bluntly, precious metals outperformed stocks by double-digit percentages after both of the last two rate hiking cycles ended.

Whether the Fed is really at the end of its cycle, or just temporarily pausing, remains to be seen.