Gold investors should be feeling pretty happy about themselves lately, mostly for sticking it out through the tough times. Over the past few months the news has been littered with articles about how the market for gold is done for, especially since gold did not go up when the markets went down like it had historically. Some things just take time, however.
There are a number of reasons why gold did not go up as expected. The main reason being that the inflation that was expected to occur because of the Fed’s Quantitative Easing (QE) policy, the billion-dollar bond-buying program designed to pump money into circulation to stimulate the economy, did not rear its ugly head. Therefore, the stock market recovered and reached record heights, driving investors away from the safety of gold. The dollar also stayed strong despite efforts by China and Russia to push for a new global reserve currency.
Many economic experts, like Ron Paul for example, strongly believe that these were just anomalies. That inflation and weakened dollar are still on the horizon and that the U.S. and world economies will not even know what hit them when those beasts arrive.
It is really telling that just two weeks ago the Federal Reserve decided not to raise interest rates, surprising most experts. Many analysts felt that all the positive economic indicators and reports that had been coming in would give the Fed the confidence to start raising rates. But those reports may have just been fool’s gold (pardon the pun). The Fed obviously is not as optimistic and decided to hold tight. Gold prices got a nice boost from this and, according to MarketWatch, “…for gold investors, the fun has only begun.”
“We can get a 20% to 30% rally from the recent lows,” Lawrence McDonald, head of U.S. macro strategy at Societe Generale, told MarketWatch.
MarketWatch is quick to point out that “McDonald, author of ‘A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers,’ is worth listening to because he has made several good trading calls on gold in the past few years.”
McDonald is definitely not taking a wild guess here. There are a couple of major factors that MarketWatch points out that signal a bright future for gold prices:
- When the Fed raises rates, the dollar is driven higher because foreign investors are drawn to U.S. assets. They’re chasing higher interest rates and the more robust economic conditions that causes the Fed to hike rates. They have to buy greenbacks, which pushes the dollar higher. In contrast, the dollar is weakened when the Fed signals it will delay rate hikes. That’s where we are now.
- The dollar and gold have a natural inverse relationship. Dollar down, gold up.
According to MarketWatch, “McDonald is bearish on the dollar because of trends blocking the Fed from raising rates, obstacles readily acknowledged by Federal Reserve Chairwoman Janet Yellen in the press conference following Thursday’s FOMC meeting. During that meeting, the committee decided to hold off on raising rates, as McDonald predicted.”
The inverse relationship of the value of the dollar to the price of gold could signal a coming spike in gold prices if McDonald’s predictions are correct. Specifically, he believes the U.S. Dollar Index (DXY) could fall to $85 from recent highs of $95. This is a big drop which could lead to an equally large jump in gold prices.
According to McDonald, predicting that the dollar will drop is as simple as understanding what the Fed wants. And, because as MarketWatch so elegantly puts it, “What the Fed wants, the Fed gets.”
5 Reasons The Fed Wants to Devalue the Dollar
So why does the Fed want this? Well MarketWatch points out five very good reasons why the Fed would be hoping for a drop in the value of the dollar.
1st Reason: The dollar is too high
Since most experts and investors believed that the Fed would raise interest rates sooner rather than later (even though we know now that it’s later), the value of the dollar has been driven higher.
The Fed does not like a dollar that is valued, in their opinion, too high, because it limits U.S. economic growth. A pricey dollar makes exports from U.S. companies more expensive, meaning other countries could look elsewhere. It also makes imports cheaper, hurting the value of U.S. products. Also, these conditions limit inflation, which is a concern for the Fed. The Fed likes to see some inflation, since that is a sign of a “healthy economy.” In addition, inflation is typically followed by an increase in gold prices.
2nd Reason: The Fed has global responsibilities
Under normal circumstances, the Fed is usually responsible for keeping inflation low (but not non-existent) and monitoring employment levels. Today’s world is far from normal, however, so the Fed also has to monitor what is happening around the world. For example, if another world power has economic issues, the Fed needs to act fast since this will affect the U.S. economy.
Fed chief Janet Yellen called these “crosscurrents.” “We need to put it all together in a picture,” Yellen said during the press conference following the Fed announcement. MarketWatch translates this by saying, “The big picture is that there are too many problems to raise rates. Weak dollar, strong gold.”
3rd Reason: The Fed is losing confidence
The fact that the Fed did not raise rates is a clear sign the FOMC members are not feeling too great about the current economic landscape. One FOMC member even discussed going to negative interest rates in order to spur growth! Desperate times call for desperate measures.
4th Reason: The upcoming Presidential election
Fed chief Janet Yellen was appointed by Barack Obama, a democrat. This fact is making many people hesitate to trust reports that the rate hike will now happen in December. The reason being, Yellen would not want to risk slowing down the economy by raising rates with an election right around the corner. Add that to the fact that it’s the holiday season and a rate hike at that time would just be wrong, and you have a formula that equals a continuation of the status quo and an ever weakening dollar.
5th Reason: Too many betting on the dollar
So many people are investing bullishly in the dollar that something has to give and it is in the Fed’s best interest that things even out. By pushing back the rate hikes, the Fed knows they are devaluing the dollar which will cause investors to sell their long positions. This will lead to a sharp drop in the value of the dollar and potentially a nice spike in gold. McDonald sees this taking a long time to shake out, which means there could be a “sustained up move in gold.”