What The Fed And The Fear Trade Could Do For Gold

Following the Federal Open Market Committee (FOMC) meeting last week, Federal Reserve Chair Janet Yellen made it clear (again) that interest rates would not be raised until inflation gains more steam. With current inflation rates negative for the first time since 2009, and with the U.S. dollar index at an 11-year high, we can probably expect near-record-low interest rates for some time longer.

Along with major stock indices, gold prices immediately spiked at Yellen’s news, rising nearly 2 percent, from $1,151 to $1,172. That’s the largest one-day move we’ve seen from the yellow metal in at least two months.

It’s also a prime example of gold’s Fear Trade, which occurs when investors buy gold out of fear of war or concern over changes in government policy.

As I’ve frequently discussed, one of gold’s main drivers is the strength of the U.S. dollar. The two have an historical inverse relationship, as you can see below.

Federal Reserve Gold

 

In September 2011, when gold hit its all-time high of $1,921, the dollar index was at a low, low 73. Today, with the dollar having recently broken above 100, the yellow metal sits under a lot of pressure. However, I’m pleased at how well it’s held up compared to the early 1980s, when gold plunged 65 percent from its peak of $850 per ounce as the U.S. currency began to strengthen.

We’re seeing the opposite effect in the eurozone as well as other regions around the world. In the last 11 months, the euro has slipped 24 percent. Many analysts, in fact, expect the euro to fall below the dollar for the first time.

When priced in this weakening currency, gold has climbed to a two-year high.

Federal Reserve Gold

 

As I write in last year’s special gold report, “How Government Policies Affect Gold’s Fear Trade”:

One of the strongest drivers of the Fear Trade in gold is real interest rates. Whenever a country has negative-to-low real rates of return, which means the inflationary rate (CPI) is greater than the current interest rate, gold tends to rise in that country’s currency.

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