The jump in the price of gold and the even huger spike in the prices of gold mining stocks tells us something really important about how the financial markets see the Federal Reserve’s action and rhetoric on Wednesday, March 15.
On Wednesday gold for April delivery climbed 2% in New York after the Fed raised its short-term benchmark interest rate by 25 basis points. On Wednesday the VanEck Vector Gold Miners ETF (GDX) roared ahead 7.69%. The more volatile VanEck Vector Junior Gold Miners ETF (GDXJ) rocketed upwards 11.53%. (I added the VanEck Vector Junior Gold Miners ETF to my new Volatility Portfolio on February 6, 2017.)
On first thought the move upwards in gold is perplexing. Gold, which doesn’t pay a dividend or provide a yield, usually sinks when interest rates rise. Higher interest rates make bonds a tougher competitor for investors’ dollars and fewer investors are, usually, willing to put up with the sacrifice owning gold requires in that situation. On Thursday gold climbed another 2.12%.
But not Wednesday or today.
Why? Think about it this way. What the financial markets have been most afraid of for the last week or more is that the Federal Reserve would signal that it was so deeply worried about inflation that it was going to move more aggressively to raise interest rates. Rate increases would come faster–after all hadn’t Janet Yellen & Co. told the markets that rates would go up in March rather the earlier consensus forecast of June? And there would be more interest rate increases in 2017 than the three the Fed had signaled back in December. In the days before the Fed meeting, it was easy to hear talk on Wall Street of four interest rate increases in 2017.
And what did the financial market’s hear instead? That the Fed was less worried about inflation than Wall Street itself had worried it might be. Fed chair Janet Yellen stressed in her remarks that the Fed was willing to see inflation nudge a little over its 2% target without getting all hot and bothered. 2% was a target not a ceiling, she said. She also repeated the Fed’s recent mantra that increases in interest rates would be gradual and that the Fed was a long, long way from beginning any selling of its portfolio holdings of Treasuries and mortgage-backed securities in order to reduce its $4.5 trillion balance sheet.
In other words,
- no four interest rate increases in 2017,
- no hurried-up rate increase, probably, in June,
- and no selling from the Fed’s portfolio that would drive up yields.
The winners in that outlook are
- gold, definitely, since the Fed just removed the worry that interest rates were about to move quickly higher and since the Fed just said that there was a good chance that inflation would run hotter than expected, and since the Fed’s actions would put less of a tailwind behind the U.S. dollar
- bonds, to a degree, since a belief that the Fed meant “gradual” when it said “gradual” would take pressure off the price of long-term bonds since long-term yields wouldn’t push up as quickly as expected
- other commodities, such as oil, since a slower pace of interest rate increases would slow the rise of the U.S. dollar and that’s always good for dollar-denominated commodities
- junk bonds and emerging market assets since a slow pace of interest rate increases and a slower pace on any increase in the U.S. dollar would relieve some worry about rising defaults at over-leveraged corporations as debt got more expensive.
How long this post-Wednesday rally in these asset classes runs is extremely uncertain at this point. Good news on the French elections–after initial good news on the Dutch elections–would help the euro against the dollar and put another damper on dollar strength. Turmoil in Washington over the Trump administration’s budget, the debt ceiling, and the expiration of the government’s spending authority at the end of April might increase the demand for safe-haven assets such as gold (and the Japanese yen) and push the U.S. dollar lower.
Those macro events all show up as possibilities in my crystal ball right now–but with a thick layer of occluding mist.