Gold prices have been stagnant because the economy is defying expectations of a recession despite tightening monetary policies by the central banks. However, a lot of the increase in US Q4-22 growth was government spending and increased trade which received the boost of a falling US dollar, hence the economic data may be painting a more positive picture of the US economy than is justified.
The ‘positive’ economic figures are what has kept gold bullion prices contained because it allows the Federal Reserve to continue to raise interest rates. However, closer scrutiny of the economic data shows that gold prices are likely to be back on the mainstream investor’s radar very soon.
Jerome Powell, the Federal Reserve Chairman, quoted Milton Freeman in a recent conference; “The monetary policy works with long and variable lags”. Some sectors such as housing and car sales are very sensitive to changes in the interest rate, but the lags can be as long as a year to 18-months before they show up in other sectors. This means that the full negative effects of last year’s interest rate hikes are not currently being seen in early 2023.
The Federal Reserve only began raising interest rates in March-22 so some of the effects of the first-rate increase is likely to begin to be felt at the end of Q1-23. Gold prices have underperformed other commodities in 2022 which has frustrated keen bullion investors but early signs of a trend reversal are becoming apparent with bullion companies raising the premium that they are paying for gold bars and coins such as gold sovereigns to attract sellers to part with their gold.
Retail spending is often cited as a reason to why a recession is not imminent, but retail spending is only marginally higher over the months since interest rates have started increasing. With consumer price inflation at 8%, retail spending should be going up much higher for the consumer to be buying the same volume of goods that they previously did.
The fact that retail spending is vertically flat means that the consumer is retrenching by buying less or buying lower quality goods. Retail spending tends to have a long lag as consumers can maintain their spending by using savings, which has been seen in the data in the US as savings from the covid lockdowns has now been depleted, once savings are spent, credit card debt begins to rise which is currently being observed.
Various credit card companies have reported the increase in credit card debts and increase in defaults. This situation is not sustainable as consumers can only spend from savings and credit card debt for so long. Consumer spending, therefore, is very likely to drop which will likely point towards a recession.
When the full effect of the Federal Reserve’s interest rate hikes have been fully recognised in the economy, it is very likely that the retail sales which have been supporting employment and economic growth will begin to fade. This will cause the central banks to unwind their interest rate rises which will push gold prices to record highs against all major currencies.
Savvy investors have been acquiring gold bullion despite the media reporting positive economic data such as growing GDP and healthy retail sales. Those that understand the lagging effect of raising interest rates will know that there is a very high probability that the economy will begin to slow and force central banks to lower interest rates.
As gold bullion bars and coins do not pay any interest or dividends, they are sensitive to interest rates. Gold has been in favour despite rising interest rates because investors are noticing that their cash on deposit may be receiving a 3% interest rate payment, but they are getting paid this in a currency that is losing 8% per annum at current inflation levels. Gold bullion investment insulates investors from the devaluation of the currency.
If central banks lower interest rates, then this will support the case for investing in bullion as the interest paid on cash balances in a bank falls even farther behind the rate of consumer price inflation.