What a Rate Hike Means for Gold
TOM BUTCHER: Hello and welcome to Van Eck Outlook. I'm your host, Tom Butcher. I have with me Joe Foster, Portfolio Manager of Van Eck's active gold strategies and the firm's senior gold analyst. Joe is acknowledged by the industry as an authority on gold and has over 30 years' dedicated experience in the field, including his time as a gold geologist in Nevada. Our focus today is possible impacts of a rate hike on the gold industry. Joe, welcome. Do you think the Fed will raise rates this year?
JOE FOSTER: Early in the year we were seeing weakness in the global economy, and I was thinking that that would prevent the Fed from raising rates. I now think that the Fed will probably raise rates later in the year. There are very high expectations in the market for a rate increase. It's very much talked about. I think if the Fed doesn’t raise rates, it would send the wrong message. It would tell the markets that there's something insidiously wrong with the economy. Therefore I do expect the Fed to raise rates later in the year.
BUTCHER: What do you think might happen to gold both in the short term and long term when there is a rate hike?
FOSTER: If the economy continues to grow and if inflation remains low, gold may continue to struggle. That's the environment we've been in for the last couple of years and I think that outlook is priced into the gold price here around the $1200 level. I think eventually a rate increase will create financial risks and unintended consequences that will drive gold higher. Whether that happens in the near term or the long term is anyone's guess.
BUTCHER: Does a Fed rate increase create any risks to the financial system?
FOSTER: Normally the Fed raises interest rates to cool an overheated economy or to tamp down inflation. That's not the case this time. In fact, maybe it's the first time ever that these are not the reasons that the Fed is raising rates. The economy's doing fine, but it's not overheated by any stretch of the imagination. The Fed wants to raise rates so they can normalize rates, i.e., get rates from 0% up into the 2%- 4% range, where they've been historically. This expansion has been going on for six years now. In June it will be six years. Since 1970 expansions have averaged around six years. We've never seen an economic expansion last more than nine years; there's a very good chance that sometime in the next couple of years we will have another recession. I believe the Fed wants to be in a position to stimulate the economy if that should happen. That creates some financial risk to the economic system; the Fed might be increasing rates for the wrong reasons, which could trigger a recession sooner than the Fed would like. Rates are higher here than they are elsewhere in the world. If they continue to go higher, capital might flow into the U.S., where it's least needed. The rest of the world is struggling economically. To starve the rest of the world of capital could cause a global recession or even depression that impacts the U.S. economy. It could also create currency instability. The dollar has been on a parabolic rise and we might see instability in the currency markets that creates financial risk. Also, stock and bond markets are at or near all-time highs. An increase in rates could cause a selloff in those markets or even burst some bubbles that might be building in the economy.
BUTCHER: One final question: how would you expect gold stocks to react to rising financial risks?
FOSTER: They are correlated very highly with gold. I think if we do enter a period of financial risk, gold stocks would perform very well. In fact, the gold companies have been doing a lot of work over the last couple of years to bring down their costs and increase their margins, and I think that will continue in 2015. The low oil prices and weak global currencies all translate to lower costs for the gold companies. I think the gold companies are positioned very well to take advantage of a rising gold price environment.
BUTCHER: Thank you very much. With Joe's very interesting views on the possible impact of a rate rise on the gold market, we come to the end of this edition of Van Eck Outlook.
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Please note that Joe Foster is the Portfolio Manager of an actively managed gold strategy
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