Interest Rate Increases Are Bearish for Gold – Revisited

The Entry Points

The current Fed rate raising cycle began on December 15, 2015. And while we all hear the wild claims about what will “obviously” be the different market reactions to the rate increase, let’s stick to the facts. The knee-jerk reaction to an interest rate increase is to sell gold. According to the consensus, rising interest rates = falling gold prices. But that theory is total crap.

On 12/9/2015, even tho a Fed rate increase was baked in, my view was it was finally time to buy gold, especially the miners. Yet the esteemed WSJ thought otherwise. Five days after my gold post, the WSJ claimed the likely rate increase, the following day, would be very bearish for gold. But as usual the WSJ, like all financial media, just follows the Wall Street line, and the hip thing to do back then was to be a gold bear (and still is).

So here’s what actually happened to the gold price in December 2015. Gold hit a rally high on 12/4/15, and then on 12/17 it fell $40 to retest the multiyear low of $1046 – two days after the first rate increase in 9 years . After that 12/17 low, gold then proceeded to rally for 7 months and hit a multiyear high of $1374 on 7/6. Interest rate increases are bearish for gold, right?

Now to show how ridiculous the rate increase vs. alleged gold market reaction is, let’s now take a longer term look. Instead of making this boring, and going thru each wildly inaccurate claim about the effects on gold of interest rate increases, let’s just focus on gold in three prominent rate increase cycles, and also one rate decrease cycle. From February 1971 to July 1974, the Fed raised rates a huge 10% points. And gold rallied about 5x up to around $200. Interest rate increases are bearish for gold, right? And then gold fell to $102 in August 1976 during the next rate decrease cycle, even though rates dropped a huge 8% points during that time. Rate decreases are bullish for gold, right? And then gold rallied to the bubble high of $875 in January, 1980. And, you guessed it, rates increased substantially that whole time. Rate increases are bearish for gold, right? And more recently, rates went up from 1.25% in June 2003 to 5.25% in June 2006 . And you guessed it, gold doubled during that time. Rate increases are bearish for gold, right?

And how about the relationship recently – gold fell from September 2011 into the low in December 2015, yet the Fed kept rates at basically zero, and globally rates were plunging. And the Fed has been raising rates since December 2015, yet gold is up. You get the idea.

So looking forward, as opposed to what the mainstream talking points are, what is possibly the single main reason why gold is so bullish, long-term? Let’s view the actual history of gold vs interest rates, which you would think is also available to Wall Street and the financial media. US 3 month T-bills bottomed in January of 1940 at .01%, and then they topped 41 years later in May 1981 at 16.8%. Forty-one years later. And gold must have fallen that whole time, right WSJ? Wrong. Gold was generally stable to rising that whole time until January 1980, as it rose from $35 to $875. Hence the conditions/the environment as to why the rates rise is vastly more important.

Why is all this so important now? Bonds and short-term paper go thru humongous long-term cycles. Bond yields had the 40+ year surge into 1981, when the 30 year yield topped at 15.2% on October 26. And one year ago the final “spring” bottom in bond yields set up beautifully with the 30 Treasury yield hitting 2.1% on July 6th, 2016 (arrow). This was the likely end of the 35 year plunge in bond yields (actually, US shorter-term yields bottomed in 2011). This will have enormous effects on all markets when the bond bear kicks back in soon.

After the Donald J. Trump victory last November, we witnessed the mass selling of bonds (and gold) and the spike in yields. So early last December, amid the 100% certainty of a “crash” in bonds, the beautiful set up arose for me to step up to the plate and buy TLT, which was discussed in this post. At that time in early December, the bearish sentiment was simply extraordinary, rarely is there unanimity of opinion as we saw then. Yet many of these same people were some of the most rabid bond bulls in early July of 2016, smack into the yield bottom. Back then, all of Wall Street was extrapolating low yields forever.

But this price rally from the December 2016 lows was just a counter-trend move within a major bear market. So with the big drop in yields (price rally) over the last 6+ months, now it’s once again time (like in July 2016) to start getting concerned about the next bottoming process in yields (top in prices).

Since the first Fed hike in December 2015, bonds and gold have generally been tightly correlated. And analysts have extrapolated this relationship to eternity. But as shown in this post, the positive correlation is not remotely written in stone as Wall Street now believes. There is much, much more to gold price movement than just at a single Fed rate increase, and then freaking out about gold – it’s the conditions/the environment as to why the rates rise which is vastly more important. Those big picture conditions currently are things such as currency destruction (not just the US$), banking problems, consistent military confrontations, the rise of India/China/emerging markets (yes Russia), general commodity bull market, etc.

So sorry Wall Street, but gold is in a huge accumulation area. And as timing is everything in markets, instead of freaking out about interest rate increases, I’ll use the sudden big selling waves/sentiment shift, “caused” by those rate increase fears, to accumulate the shiny metal. Because the slow, steady mass exodus in bonds over the next few decades, will be very bullish for gold.