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Gold & the ‘know nothing’ Fed

Gold’s descent to its lowest since the end of January does not make a strong case for short-term profit seekers.

This year’s 17-percent rise to the middle of March and the eight-percent rise in June now look like a bull trap to technical traders, a sucker’s rally that pulled in new money only for the slump starting at the September 2011 peak of $1,920 to resume.

Silver looks worse again, trading near four-year lows beneath $18.70 per ounce. So plenty of internet pundits, in contrast, will surely claim this drop was engineered to mask runaway inflation in the cost of living – i.e. a continued loss in the value of money.

Derivatives traders have indeed thrown a mountain of bearish bets into the precious metals market. But it is now ‘speculative’ money managers, rather than ‘commercial’ traders from bullion banks, who hold their largest short position against gold on record. And whatever your experience says of rising prices and shrink-flation, the bond market also thinks inflation is receding.
US inflation-linked bond yields have risen, analyst Walter de Wet at Standard Bank has noted, and the yield on five-year inflation-linked bonds “represents the five-year average real interest rate”.

Put another way, expectations for the real rate of interest – meaning the interest rate after accounting for inflation – has risen. And that is classically bad for gold investment or, at least, for perceptions of gold’s investment outlook.

History says there is no constant relationship between gold prices and nominal rates. Indeed, gold prices and the Fed Funds rate have moved in opposite directions only half the time over the last 45 years, rising or falling in tandem in the other half.
But looking at the real rate of interest, accounting for inflation, real gold prices (again, accounting for inflation) tend to rise much faster when real rates fall. Since 1969, gold’s annual gains have averaged nearly 10 percent above US inflation when real rates fell compared with only 2.5 percent during periods when real rates were higher from 12 months previously.

For gold investors today, the question isn’t so much whether or when the Fed might raise rates but whether it would dare to raise rates faster than any pick-up in inflation.

Source The Bullion Desk

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