By now, you’re aware of the Federal Reserve’s plan to raise interest rates several times this year and next. I believe regular rate hikes over the next couple of years are even more likely following news that the consumer price index (CPI) for January reached a stunning 7.5% – the highest level in 40 years. Inflation is running hot and right now seems destined to grow only hotter.
For many, this significantly higher risk of interest rate hikes has weakened enthusiasm for gold. That’s because, generally speaking, higher rates are viewed largely as bad news for gold. As assets compete with one another for investor money, higher rates mean increased attention to fixed-income assets such as bonds. Physical gold – and silver – don’t offer savers an opportunity to earn interest or dividends.
I can hear some of you now: “But what about inflation? Why would investors care more about modest interest rate hikes when inflation is at a 40-year high?”
That actually is a clever response. And it’s also why multiple Wall Street asset managers who oversee a big chunk of money have decided to stand fast on their present gold allocations even as our central bank moves away from lower interest rates.
These managers acknowledge that the long period of extremely low interest rates likely is coming to an end. But they also recognize what you see, as well: Nominal rates would have to go much higher from here before real rates (nominal rate minus inflation rate) can climb out of negative territory. And so they like what they see ahead for gold right now. Maybe you do, too.
Let’s drill a little deeper.
I’ve talked before about the way negative real rates can be a fundamental driver of gold and silver. And there’s no disputing real rates are negative – deeply negative – right now.
How negative? According to BankRate.com, the best a saver can do currently on a five-year certificate of deposit (CD) is 1.30% (APY). Now subtract the whopping 7.5% inflation rate from that 1.30% and our retirement saver is currently “earning” – in terms of a real rate – negative 6.2%.
The Federal Reserve would have to significantly raise rates – against the backdrop of a fragile, debt-laden economy – to prompt interest-bearing vehicles to pay enough so that real rates are again positive.
This brings me back to the Wall Street money managers and their decision to remain true to gold.
One of those managers is Christoph Schmidt of German asset managers DWS Group. Schmidt oversees the near-23-billion-dollar portfolio of DWS’s Multi Asset Total Return fund. And Schmidt is one of the asset managers who’s leaving his gold allocation – currently 8% – right where it is precisely because he doesn’t anticipate the interest rate environment changing a whole lot.
“I would not expect our gold position to change in the foreseeable future,” Schmidt confirmed to Bloomberg recently. “We don’t see a dramatic change in the interest-rate environment.”
Notice that Mr. Schmidt said, “Dramatic change.” A dramatic change would mean a significant rate-tightening scheme that leads to interest rates equaling or exceeding the inflation rate – which would bring real rates to the plus side. I’m not aware of any asset managers who see that happening, however. It seems very few believe the economy is strong enough to support substantially higher rates, let alone rates that would be on par with the actual year-over-year inflation rate.
That means inflation could be “off to the races” for some time to come, a condition that in its own right could provide a big assist to gold. Michael Cuggino, president at Permanent Portfolio Family of Funds in San Francisco, says “inflation is primarily a money creation issue.” He told Bloomberg, “We see gold making higher highs and higher lows going forward due to the amount of liquidity created over the last couple of years.” One of Permanent’s funds, the namesake Permanent Portfolio, has a full 25% of its assets under management invested in metals right now.
Other data suggests there may be more than meets the eye to the simple notion that higher rates equal trouble for gold. For example, while 2021 was a slightly down year for the price of gold after a robust 2020 (+25%), it’s worth noting that gold ETFs (gold exchange-traded funds) have been experiencing net inflows since the beginning of 2022.
Here’s the significance: Fund flows are seen as a meaningful indication of investor sentiment. In the case of gold ETFs, net-positive inflows in January imply investors’ confidence in gold is growing. And that might seem curious to the casual observer inundated with nonstop chatter about impending Fed rate hikes.
But the sharp upswing in money to gold ETFs is not so curious to those who believe that while there may be no built-in ceiling to the inflation we’re experiencing right now, there is a ceiling on Fed rate increases due to concern over weak economic growth. And that ceiling may prove to be pretty low. If negative real rates persist and a net positive real interest rate remains elusive, it could contribute significantly to a positive gold climate for the foreseeable future.
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