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Is a December Rate Hike Necessarily Bad News for Gold?

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Conventional wisdom holds that an interest rate hike in December will be bad for gold.

But will it?

There is actually evidence the opposite could be true.

Higher interest rates generally boost the dollar. This puts downward pressure on the price of gold. So, one would expect a rate hike to cause gold to tank. But over the last two years, the opposite has happened. In fact, we have seen double-digit increases in the price of gold after rate hikes.

So what gives?

The biggest factor is that we generally know the Federal Reserve is going to raise rates long before it actually acts. We’ve heard talk of a December rate hike since July. In fact, analysts say the likelihood of a quarter point December hike stands at 97%.

So, with several months to anticipate a hike, it is generally already baked into the price of gold by the time it happens. The market has been factoring it in all along. The Economic Times of India provides a succinct explanation of what has happened over the last two years.

The much-anticipated rate hike is viewed as bearish and so gold prices already face continuous selling pressure. So after the rate hike, investors go for short covering or unwinding their bets and that is where we see the bounce even if the news is negative for gold. The rate hike from FOMC is predictable and so any upcoming highly anticipated Fed meeting comes, the deep-pocketed speculators go long on the US dollar and short gold futures. When the rate hike happens, it closes out their trades by buying gold future and selling the US dollar. This prompts the rally in gold prices. This can be seen from the weekly chart when Fed chair Janet Yellen hiked rates in December 2015 and December 2016. In March 2017, the same thing happened.

The question then becomes: Can the market sustain the rally?

That all depends on what investors think the Fed will do next. If Yellen and Company project a hawkish tone, and people think another hike is on the horizon, the “relief rally” will fizzle out pretty quickly. But if the Federal Reserve seems more dovish, and it looks like the Fed will slow the “normalization” process, the rally could extend, leading to more double-digit gains for gold.

The Economic Times article views the Fed as relatively dovish and looks for gold to track upward again after the December rate hike.

The last US economic outlook given by the Fed was positive but Fed was also appearing towards caution and so we expect Fed to remain behind the curve. This gives opportunity for yellow metal to appreciate. So in fact, we expect gold prices to remain under pressure till Fed meeting but after that we expect gold to touch $1,330-$1,350.”

TD Securities also expects fewer rate hikes and a weakening dollar on the horizon.

Based on the recent Fed trend of continually dropping its dot plot estimates and ongoing concerns that their models may be misspecifying inflation, there is a good chance that the world will get less than the four cited rate increases over the next twelve months. This could in turn lead gold traders to speculate that the FOMC may lower its terminal rate projections down from the current 2.75 percent, as low inflation would require low real interest rates.”

There is also the issue of the overheated stock market.

As we reported earlier this week, 46% of investors now acknowledge the stock market is overvalued. TD Securities analysts see the potential for gold and silver to shine due to this fragility in the stock markets.

With equities in record territory and pricing in both low rates and earnings perfection, there will be a growing constituency who believe that there is more downside than upside risk. This historically has meant that investors beef up gold and precious metals exposure as a hedge.”

The bottom line is, the Fed’s next move might not bring about the doom and gloom some investors think. In fact, this might be a good time to buy.


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