Could Gold Shine in 2022 Despite the Fed’s Proposed Inflation Fight?

Despite an inflationary freight train, gold struggled to gain ground in 2021 as the markets fixated on the Federal Reserve and the possibility of tighter monetary policy to fight inflation. Will gold continue to fight headwinds in 2022 as the Fed launches its “inflation fight,” raises rates and possibly begins to shrink its balance sheet? Or could gold shine in 2022 despite the Fed’s feckless inflation fight?

The World Gold Council released its Gold Outlook 2022 report. Despite the likelihood of tighter monetary policy, it sees reason to be optimistic about gold’s trajectory in the coming year. As the WGC put it, “rising rates pose risks, but the devil will be in the details.”

The Federal Reserve now plans to raise interest rates three, possibly four, times in the next year. The conventional wisdom is that these rate hikes are bearish for the price of gold. This is why every time we got hotter than expected inflation news last year, the price of gold fell. Everybody assumed the central bank would speed up the pace of these rate hikes.

The World Gold Council report highlights three key reasons the Fed’s hawkish stance may not be the problem for gold many people think it will.

Actual Tightening Has Historically Fallen Short of Projections

The Fed tends to overpromise and underdeliver when it comes to raising rates. Dot-plot projections suggest that year-ahead Fed expectations have significantly exceeded actual target rates.

There has also historically been a “sell the rumor buy the fact” tendency in the gold market when it comes to rate hikes. We saw “sell the rumor” play out throughout 2021. As the WGC points out,  gold has historically underperformed in the months leading up to a Fed tightening cycle, only to significantly outperform in the months following the first rate hike. The US dollar exhibits the opposite pattern. Finally, US equities tend to have their strongest performance ahead of a tightening cycle but deliver softer returns thereafter.

Inflation May Linger

As Peter Schiff has explained, the Federal Reserve’s plan to hike rates to 2% (maybe) over the next two years isn’t nearly enough to fight 7% inflation. The Fed seems to be locked into a “hope and pray” monetary policy. Jerome Powell still wants us to believe that inflation is transitory. He still insists that “supply chain problems” will resolve in 2022 and lower some of the inflationary pressure. As Peter pointed out, Powell’s been wrong about “transitory” so far. Why should we believe him now?

Even though the Fed, or Powell, has claimed that they were wrong about inflation being transitory, they’re basically still clinging to that lie. Because they’re just saying that the transition is going to take longer than we thought because they think the inflation problem is going to take care of itself.”

The World Gold Council is skeptical that inflation will cool.

We believe there are multiple reasons why inflation will remain high, partly stemming from the unprecedented monetary and fiscal policies put in place to alleviate the effects of the COVID-19 pandemic.”

Gold has historically performed well in high inflation environments. In years when inflation was higher than 3%, gold’s price increased 14% on average. And in the long run, gold has outpaced US inflation and moved closer in pace to money supply, which has significantly increased in recent years.

Real Interest Rates Will Likely Remain Low

This is a point Peter Schiff recently made in a video.

Everybody is fixated on small nominal interest rate hikes. But even if the Fed follows through with its modest rate 2% rate hike, real interest rates will likely remain deeply negative.

Real interest rates equal the nominal rate (the numbers quoted on the news) minus inflation. Today, the nominal rate is 0%. Inflation is running at around 7.3% (using the cooked government numbers). So, the real interest rate is -7.3%.

The World Gold Council report said high inflation will likely keep real rates depressed.

This is important for gold since gold’s short- and medium-term performance tends to often respond to real rates, which combine two important drivers of gold performance: ‘opportunity cost’ and ‘risk and uncertainty.'”

Holding gold does not generate interest income like a bond or a bank account. If interest rates rise and you’re holding gold, you’re forgoing the interest income you could earn if you instead owned a bond or put dollars in a money market account. That’s why rising interest rates tend to create headwinds for gold. And it’s why we’ve seen gold sell off on high inflation news. The markets expect the Fed to fight inflation with rate hikes, thus raising the opportunity cost of holding gold. But when real rates are negative, there is no opportunity cost. In fact, the opportunity cost is in holding rapidly devaluing dollars.

The WGC also notes that low interest rates – both nominal and real – shift investment portfolios more towards risk-on assets. This, in turn, increases the need for a high-quality liquid asset such as gold.

In addition to these monetary factors, the World Gold Council projects that a rebound in gold jewelry demand and continued central bank buying could help boost overall gold demand. You can read the entire WGC report HERE.