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Janet Yellen and Gold Prices

Fanning the Flames of Inflation

Written by Briton Ryle
Posted October 14, 2013

If you have ever taken a moment to follow an eagle flying above a canyon, or a seagull at the beach, you may have noticed how they can often gain altitude without flapping their wings a single stroke. How? By riding columns of warm air, whose faster moving and thus lighter molecules rise.

While gold has been dropping like a stone in water over the past couple of years, the case can be made that Janet Yellen’s succession of Bernanke as Federal Reserve Chair in three months’ time would give gold a lift back up to the stratosphere, given her dovish, loose-money stance.

GOLD OUTLOOKBut isn’t the Federal Reserve expected to begin reducing its monthly bond and mortgage purchases down to zero, ultimately strengthening the dollar and weakening gold even further? Where would this column of rising hot air lifting gold higher come from? For years it seems the only hot air has been coming from gold advocates who seem too enamored with gold to face the reality that gold’s bull run is over.

Indeed. But the Fed's longer-term plan is to keep stoking inflation, fueling the economic equivalent of a controlled forest fire.

The Fed’s Firestorm

This controlled stoking of inflation began at the height of the 2008-09 financial crisis, when the Federal Reserve lowered its benchmark interest rate to a level below the inflation rate. (click to enlarge)

inflation rate 10-14-13 smallSource:

At the end of 2009, the inflation rate (light blue) crossed back into positive territory, where it has remained above the Fed’s benchmark interest rate (dark blue) of 0.25%. This creates “negative real interest rates,” where the dollar’s gains through interest cannot keep up with consumer price gains through inflation. The dollar will continue to lose ground as long as the benchmark interest rate remains below the inflation rate, to which the Federal Reserve has remained staunchly committed.

For how long? “At least as long as the unemployment rate remains above 6-1/2 percent” and inflation “is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal,” informs the Fed’s press release.

These loose money policies had already lifted gold from $730 in 2008 to $1,925 by mid 2011 – a rise of 163% in three years. While gold has corrected some 30% since that all-time high, the underlying conditions for the economy are still burning.

The latest figures before the government shutdown showing 7.3% unemployment and 1.5% inflation indicate no change to the Fed’s loose-money policies anytime soon. But might things change when Yellen takes over February 1st?

Will Yellen Keep Fanning the Flames of Inflation?

Jeffrey Rosen, chief economist at, believes Yellen will keep the easy-money fire burning. “Inflation is trending well below target levels and you have unemployment still elevated. You have no sign of an accelerating economic recovery. So I don’t see how the Fed under any (chairperson) could change the current path,” he opined to Forbes.

Sean Lusk, director of commercial hedging with Walsh Trading, agrees. “She’s been dovish just like Bernanke has,” he assessed to Forbes. “Her speeches and commentary over the last couple of years, since the financial crisis, has been in line with the current Fed chairman. That has been bearish dollar, bullish metals, at least in my view.”

A weak currency is many a central banker’s remedy for a slowing economy, as cheaper capital enables business expansion, which leads to more hiring. As Yellen is expected to keep dollar-weakening policies in play, gold may soon catch another rising column of warm air to lift it higher.

But what about those expected reductions to the Fed’s monthly bond and mortgage purchases? Won’t that slowing of liquidity strengthen the dollar and weaken gold? Where does Yellen stand on tapering?

Carlos Sanchez, director of asset management with CPM Group, thinks she will cut stimulus. “I think she’s going to stick with the game plan,” he predicted to Forbes, “which is … as long as the economy is improving, they are going to taper the asset purchases. That should weigh on gold, whether that occurs later this year or early in 2014.”

Remember, this is supposed to be a controlled burn, where the Fed wants to stoke inflation but still keep it under control; it won’t simply sit back and just let inflation run amok. Tapering purchases and eventually tightening rates are part of the plan to slow inflation down when it reaches the Fed’s 2 to 2.5% target area.

In its Statement on Longer-Run Goals and Monetary Policy Strategy, the Fed acknowledges that “monetary policy actions tend to influence economic activity and prices with a lag.” So it is quite possible that Yellen will want to begin turning off the money tap slightly ahead of reaching those inflation targets.

However, Sanchez notes an important qualifying condition… “as long as the economy is improving.” For the first half of this year, things were going pretty well, with jobs being added at a rapid pace and home purchases steadily rising. Hence, the Federal Reserve introduced the idea of bond tapering back in May.

But since then, bond and mortgage rates have picked up, job creation has slowed down, and the housing market has begun cooling. Add to that the hit to the economy dealt by the two-week government shutdown, and the tapering of monthly purchases may have to wait a while.

“The question is what is going to happen with the quantitative-easing program,” Sterling Smith, futures specialist with Citi Institutional Client Group, posed to Forbes. “[Yellen]’s probably not going to be as big of a risk as some people might be about cutting the quantitative easing,” he proposes.

“What you may find with Yellen,” Rosen elaborates to Forbes, “is she may keep rates lower and quantitative easing going on slightly longer than a more hawkish (chairperson)… To me, we’re going to see more of the same easy, accommodative monetary policy. Fed funds [benchmark interest rates] will probably not move until 2015, if not later, and tapering probably won’t start until 2014.”

Hold for the Rising Column

The trend in the gold market has, since the end of August, turned downward once again, failing to mount any rise throughout the entire government shutdown. “This lack of response to the U.S. shutdown may mask an underlying negative investor sentiment,” James Steel, chief precious metals analyst at HSBC, explained to Reuters.

Not even Yellen’s nomination last week was able to move gold higher, with Wednesday’s small $10 gain given back in Thursday’s and Friday’s combined $40 drop. Gold looks like a “broken market right now,” Market Watch cites Andrew Thrasher, investment analyst at Financial Enhancement Group, who cautioned, “When it's unable to rally on good news, you have to take notice.”

Gold’s tumble by week’s end came as the Republican-led House of Representatives agreed to a temporary debt limit increase, greatly reducing the risk of a government default later this week.

gold 10-14-13Source:

As noted in the graph above (click to enlarge), gold has not been able to break above a yearlong downtrend (red), which has recently steepened lower. Once it fell through the summer rally’s support line (green), gold has been trapped inside a descending channel.

Anyone wishing to trade a channel would simply buy when the price nears the channel’s lower support, where gold is now, and take profit when the price moves back toward the channel’s upper resistance. The critical level to watch is June’s low of $1,180 (blue), which may soon be revisited.

Even so, gold should not be dismissed from one’s portfolio, as it has greater upside potential than downside risk. Estimates from Goldman Sachs (NYSE: GS) and others call for a $1,125 low for the gold price in 2014, and we’re really not far from that now.

The shockwave when Fed tapering begins in early 2014 is pretty much the last barrier holding the gold price down. Once the event passes, there is really nothing left to stand in the way of higher gold prices until interest rates begin rising – which one expert believes may be years away.

Bond guru Bill Gross of PIMCO recently wrote in a client newsletter obtained by CNN Money, “The United States (and global economy) may have to get used to financially repressive - and therefore low policy rates - for decades to come.”

So between the end of the Fed’s monthly purchases and the raising of interest rates, gold should find another sweet spot similar to the one it enjoyed from the end of the 2008 crisis to its all-time high in 2011.

“If you want to trust one thing and one things only,” Gross continued in his letter, “trust that once QE is gone and the policy rate becomes the focus, the fed funds [rate] will then stay lower than expected for a long, long time.”

Joseph Cafariello


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