Why Gold Investors Shouldn't Worry About a Rate Increase

We’re back to the old Fed-watching game of will-they/won’t they. The question is: Will they or won’t they raise interest rates? One minute Janet Yellen strikes the word “patience” from her latest statement and all of Wall Street is aflutter. The next minute we have a terrible manufacturing report and its back to square one. So will the Federal Reserve raise interest rates this year? When? And what will happen to the dollar and to gold if that happens? Should you listen to the people who tell you to sell your gold or refrain from buying more based on their predictions of a rate increase?

Many gold bears say that gold will not be able to compete in a non-zero interest rate environment. They say it looks like the Fed is still on track to raise rates this summer, and when that happens, gold will be abandoned in favor of yield-bearing assets. We disagree with this on all points. Here’s why.

First of all, we will believe the interest rate increase when we see it. Raising interest rates is a dollar-strong move and we are in a global sea of quantitative easing. All around us, every major currency is being printed into oblivion, which is making the dollar relatively strong.  Dollar strength right now is not remotely the dollar’s fault. The dollar is just an innocent bystander watching other world currencies get beaten to a pulp.

However, because of dollar strength, our manufacturing industries are getting hammered. Our exports are relatively more expensive when the dollar is strong. This factor is putting a lot of pressure on the Fed to adopt more “dovish” weaker dollar policies, and raising rates ain’t one of ‘em!

The Fed’s dual mandates are low inflation and full employment. We already know they are completely unconcerned about inflation. But if we start to hemorrhage jobs from manufacturing – again – the Fed will be seen as having failed in that mandate. Janet Yellen has a very dovish reputation, so expect her to respond accordingly and not raise rates.

Another key point here is that there IS inflation. There is A LOT of it, it just so happens to be hiding in plain sight. It is in the market, pumping the prices of equities up into the stratosphere. Have you looked at the fundamentals of the market lately? There is no relationship anymore between profits and price. Dollars have flooded Wall Street making stock prices shoot up, giving a false sense of wealth and value. But this is just another bubble. Wait until the selloff begins. Selling an overpriced stock means those shares will be converted back into dollars and the inflation will just slosh from the market onto Main Street. That is when we will see inflation in the traditional sense – with a massive amount of Wall Street dollars chasing fewer goods on Main Street. Prices at the grocery store will triple. Greenspan himself is warning of this.

When this selloff hits, prices for stocks will drop rapidly. All those gains that people now see on their monthly brokerage statements will mean nothing because they can no longer be realized.

The great concern is that so many average American investors have been lured into the promise of big returns. They buy the line that gold doesn’t pay dividends, so why own it? The problem is that dividends and yields come with such a dangerous risk of total loss. It is important to diversify your portfolio into different sectors and instruments, but don’t neglect to include the backstop of precious metals against massive and sudden market corrections. When all of that froth clears out of the market, will it wash away your net worth right with it? Or will you have the protection of solid gold?

Gold is a different type of investment, owned for different reasons than stocks and mutual funds. True, it doesn’t pay interest, but it also holds its value. In a correction or crash, that will suddenly matter much more to you. It also resists inflation and tends to move counter to the market. For these reasons, a rate increase will not significantly hurt gold and gold investors. It may strengthen the dollar so that it buys more gold, but that is the very reason the Fed will resist enacting one.