So, why hasn’t gold taken off?
We hear this question over and over again. In this video, Peter Schiff answers this question and explains why the markets will eventually wake up to their misperception.
That’s the key word – misperception.
Taper tantrums and fear of Fed rate hikes have distorted perception in the markets. People are selling gold when they should be buying gold on the dips.
And at the root of this misperception is the market’s focus on nominal interest rates instead of real interest rates.
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.
Gold has been rangebound around $1,800 for months. Peter pointed out that the fact gold hasn’t really gone down despite this universally held belief that monetary tightening is negative for gold is a positive sign.
But it’s key to understand that not only are these projected rate hikes not negative for gold – they are actually going to be a positive.
The Missing Puzzle Piece – Real Interest Rates
Why do investors assume rate hikes are bad for gold?
Generally speaking, rising interest rates increase the opportunity cost of holding gold.
Gold does not generate a yield. If interest rates rise and you’re holding gold, you’re forgoing the interest income you could earn on dollars if you put them in a bank account or invest them in bonds. 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.
Rates have been at zero for a long time. That means there has been no opportunity cost to own gold. The Fed’s artificially low interest rates have been supportive of gold. The fear (and misperception) is if the Fed removes those supports by raising rates, gold will crash.
Peter says that’s not going to happen.
The key is understanding the difference between nominal interest rates and real interest rates.
“When you’re talking about an opportunity cost, the interest rate has to be real. And by real, I mean above the rate of inflation.”
Even based on the government’s flawed CPI, inflation rose by about 7% in 2021.
“Even if the Fed follows through with all of the rate hikes that it’s projecting, it’s talking about slowly raising interest rates in one-quarter point increments until, at the end of this year, they’re at 1%. And they’ll continue the process in 2023 until at the end of 2023, we’re at 2%. And supposedly, the 2% rate of interest represents a huge headwind for gold because it’s an opportunity cost, and a lot of people that are in gold are not going to want to be in gold when they can get a 2% yield on their cash.”
Peter said the whole idea is absurd.
If you accept a 7% inflation, even though the actual rate of inflation is probably 15% if the government measured it accurately, that means the dollar is losing 7% of its purchasing power every year. In exchange for that, you’re going to be able to earn 2% in interest to offset the 7% you’re losing to inflation. You are still -5%.
“Negative 5% is not an opportunity cost. Nobody wants the opportunity to lose 5%. So, if you’re giving up a 5% loss, you’ve given up nothing.”
In order for there to be an opportunity cost, you have to have an interest rate above the rate of inflation. If the Fed raised rates to 10%, that might be a problem for gold. With an inflation rate of 7%, you would be giving up 3% in real interest that you could otherwise earn.
“But if they’re just talking about raising rates to 2%, that’s nothing! I’m going to stay in gold to avoid a 5% loss. The opportunity cost is not owning gold. It’s owning US dollars and losing 5%. What the Fed is doing is too little too late to derail the gold bull market.”
In fact, Peter said he thinks the Fed will initiate the next leg up for gold when the markets wake up to this reality.
The Inflation Fight the Fed Can’t Win
Right now, everybody is fixated on the Fed’s fight against inflation. They assume that the central bank is going to win. So, why own gold?
At some point, the markets will realize that these incremental, tiny rate hikes are not nearly enough to stop inflation. The Fed is way behind the curve, and inflation is rising much faster than the Fed is talking about hiking. In fact, the Fed isn’t really talking about tight monetary policy at all. The Fed is talking about slightly less loose monetary policy. Less loose isn’t tight.
“What the Fed is talking about doing is reducing the amount of gasoline that is pouring on the inflation fire. That still means the fire is going to get bigger. Even if it gets bigger more slowly, it’s still going to get bigger.”
But Peter said he thinks it may get bigger even faster.
“When the markets realize these rate hikes aren’t doing any good, and that inflation is getting worse, that’s another reason to buy gold.”
And while the rate hikes won’t be big enough to tame inflation, they may well be big enough to prick the bubble economy.
“When you develop an addiction to a certain amount of monetary heroin, even if you get monetary heroin, but you get a smaller dose, it’s not enough for your habit. And I think that’s going to happen in the markets.”
Ultimately, it will bleed into the economy and drive it into recession. That means we’ll not only have inflation but stagflation.
“In the face of that, the Fed is ultimately going to do an about-face. It’s going to start cutting interest rates again and restarting the QE program even though the inflation problem has gotten worse.”
When that happens, gold is going to go ballistic.
“But between now and then, take advantage of the misperception in the market that these rate hikes, if they actually come, are bearish for gold. That’s keeping a temporary lid on the price of gold. Eventually, reality is going to blow that lid off. But in the meantime, buy yourself some gold. In fact, maybe even better, buy some silver as well.”
This sale is not going to go on forever.
“When you get a gift horse, don’t look it in the mouth. Just take advantage of it.”