Precious metals have had a somewhat mixed week and it’s all probably down to expectations with respect to US inflation. Inflation, and any attempts to control it, can be something of a two-edged sword for precious metals.
While they are generally seen as something of an inflation hedge, whether justifiably or not, higher interest rates, used to try and control inflationary trends, can also be something of a negative factor for gold in particular. Precious metals are non-interest paying assets, but this means they appear to be strongest when interest rates are effectively negative – i.e. lower than the inflation rate - as they are at present.
However, if the US Federal Reserve does raise interest rates, it would probably only be by a tiny amount so the chances are that they would still effectively remain in negative territory. Higher US interest rates can raise the dollar index, though, which has been trending weaker of late, and a higher dollar tends also to lead to a lower gold price in dollar terms.
The US Fed though has gone on record as emphasizing that a return to pre-pandemic employment levels is its main priority and is thus, for now, holding firm on its low-to-zero-to-n real interest rate policy and continuation of QE at current levels.
It has been undershooting its 2% inflation target for many months, and thus its logic seems to be to allow inflation to rise above this level for a period in order to bring its average rate up to the target level. The big question here, though, is does it possess the tools to keep the possibility of sharply rising inflation under control as the US recovers from the impact of the pandemic and the resultant inflationary build-up?
To an extent, whether the Fed can keep inflation under control may depend on how great the inflationary pressures actually are. Fed chair Jay Powell has gone on record as claiming that any inflation rate rise is likely to be purely transitory, and perhaps in the way the Fed measures inflation that may well be the case. But this tends to be viewing inflation through rose-tinted spectacles and the Fed’s inflation perspective bears little relation to the kinds of inflation levels currently being experienced by the American public which is probably in excess of 4% annually.
Regarding inflation and the Fed’s likely reaction, US Treasury Secretary, Janet Yellen, may have inadvertently let the cat out of the bag. If anyone knows how the Fed works and thinks, it is Yellen, as a former Fed chair. And she is reported as saying “It may be that interest rates will have to rise somewhat to make sure our economy does not overheat, even though the additional spending is relatively small relative to the size of the economy”. The comment caused some confusion in the markets and Yellen was quick to backtrack, stressing that she was not predicting or recommending an imminent increase in interest rates. However, that carried the impression that she was just trying to calm the markets in the way that politicians do in the interests of damage limitation.
With the appointment of Yellen as Treasury Secretary, there is an impression that the Biden Administration is attempting to merge the opinions, if not the actual policies, of the Fed and the Treasury, despite the former’s supposed impartiality. If this is indeed the case, then any statement by Yellen is likely to mirror the Fed’s views closely, but in this case she perhaps misjudged her initial statement in making it more significant in its interpretation than the kind of coded non-committal statements that tend to be the Fed’s post- Federal Open Market Committee (FOMC) meeting statement hallmarks.
We thus suspect that the Fed may well indicate that it might indeed start to raise interest rates, albeit by a very small amount, sooner than it has previously been forecasting. This decision would probably happen in its deliberations at the next FOMC meeting, which takes place in mid-June. If that is the case, it may thus be seen as the Fed recognizing that inflation is rising faster than it would like, although it still would seem to have plenty of leeway given its many months of an undershot inflation target level.
In the past the mere suggestion that the Fed might be about to start raising interest rates would have been taken by the markets, at least initially, as being negative for precious metals and equities prices. This time around though, any such announcement could be taken as indicating that serious inflation worries are in evidence. Nevertheless, the likelihood is that interest rates will still remain effectively negative and, in such a scenario, we suspect that precious metals prices could receive a boost, driving them to the next level – perhaps to $1,900 for gold and $29 for silver. At the same time, though, equities prices and bitcoin might well fall back as the latter already seems to be doing, so be warned.
The Fed’s seeming reluctance to raise rates at all for the time being, probably stems from the possibility that any perceived tightening of its policies could precipitate a severe downturn in equity prices. As long as these seemingly ever-continuing upwards price movements continue, the US Government can keep maintaining that overall its economic policy is working.
However an equities downturn, if prolonged, or steep, could give the opposite impression. Last time the Fed raised rates the equities markets rapidly turned south and the Fed came under extreme pressure from the then-Trump Administration to quickly reverse its decision, which it did. The equity indexes are the most visible signs of economic strength, if not necessarily the most accurate ones.
Many commentators thus feel that the statements following June’s FOMC meeting will give the hint that there may well be a rise in interest rates ahead, albeit a very small one. If that is the case, then there will be the broad conclusion drawn that the Fed is at least a little worried about rising inflation and the markets may well react accordingly.
Gold and silver will likely trade a little higher and equities may come off a little. The pgms as primarily industrial metals may also weaken. But, unless there are signs that the Fed could pursue a continuing series of interest rate advances, such precious metals and equities price movements could be limited and of short duration.
Overall the impact, at least in June, would likely be extremely limited. It is whether the Fed, at subsequent FOMC meetings – or even between such meetings – gives the slightest impression that further interest rate rises lie ahead that the markets could be spooked.
For the time being, the Fed seems confident that it has the tools to keep runaway inflation well under control and any inflation rises are indeed purely ‘transitory’ (the current Fed buzz word).
by Lawrence Williams
Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.