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Fed way behind curve, real rates to remain deeply negative

By Mike Gleason
web posted December 20, 2021

As the Federal Reserve prepares to taper its asset purchases, investors are preparing to adjust their portfolios.

Some are dumping gold. They could be making a big mistake.

Sentiment toward precious metals turned negative as prices fell over the past few weeks. Gold and silver markets continued to slide ahead of the Federal Reserve’s policy meeting last Wednesday.

However, they got a bounce following the Fed’s recent announcement that it would double the pace of tapering in 2022 and raise interest rates up to three times.

PBS News Anchor: Federal Reserve officials announce that they are prepared to fight inflation with a series of interest rate hikes next year, suggesting it will begin earlier than they projected just months ago.

Jerome Powell: We are committed to our price stability goal. We will use our tools both to support the economy and a strong labor market, and to prevent higher inflation becoming entrenched.

PBS News Anchor: The Fed also announced that it will scale back even further its efforts to stimulate the economy through major bond purchases.

The central bank may well soon begin reducing its asset purchases, but that’s not the same thing as reducing its balance sheet or the money supply. Far from it. In reality, even after tapering, the Fed will continue to hold its existing hoard of bonds and replace them as they mature.

Recent blowout readings on the Consumer Price Index and Producer Price Index suggest the Fed is way behind the curve on tightening. It almost certainly won’t get out in front of inflation next year with three measly quarter point rate hikes.

Could the Fed’s move to taper and eventually hike rates mark a significant bottom in precious metals markets? It’s quite possible.

Naysayers claim that Fed tightening will be bad for gold and silver markets. Rising rates are a headwind for metals – or so the conventional wisdom goes.

There’s a lot of misinformation out there on the relationship between gold and interest rates. Some commentators confidently assert that higher interest rates are bullish for the U.S. dollar and therefore bearish for gold.

While that may seem logical in theory, it often doesn’t bear out in reality.  

Consider that the gold market reached its last major bottom in December 2015 at around $1,050 an ounce. That happened to coincide with the onset of a Federal Reserve rate raising campaign.

Previously, a third round of Quantitative Easing was announced in September 2012.  At the time, many analysts assumed that QE3 would provide an immediate boost to gold and silver prices.  Instead, the metals markets declined for several months following the Fed’s announcement.

The lesson is that precious metals markets don’t move in direct lockstep with Fed easing or tightening.  Gold and silver prices show virtually no correlation to nominal interest rates. 

What matters is real interest rates – meaning, rates relative to inflation. Real rates can remain negative throughout a Fed tapering and hiking campaign.

Real rates are currently at one of their most deeply negative levels on record thanks to the recent inflation spike. And yet gold and silver prices don’t seem to be responding as they should.

That’s understandably a source of frustration for precious metals holders. Some critics claim that gold no longer serves as an inflation hedge.

But you’d have to be very short-sighted to come to that conclusion. At this time 20 years ago, gold was trading at under $300 per ounce. It’s come a long way since then as the value of the dollar has steadily declined.

Gold will continue to offer long-term inflation protection, though its ups and downs from year to year will be difficult to predict. Inflation is here, and central bankers won’t be getting out in front of it anytime soon.

The bottom line is that if you wait for the Fed to start cutting rates again or launch a new QE program before seeking refuge in precious metals, you may miss the next big move higher. ESR

Mike Gleason is a Director with Money Metals Exchange, a national precious metals dealer with over 50,000 customers. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.


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