Federal Reserve, U.S. Dollar: 2 Factors Supporting Higher Gold Prices

Gold PricesI am looking at two factors to see where gold prices are headed next: the Federal Reserve’s actions and the U.S. dollar. They are unanimously pointing toward the upside.

Let me explain…

Price of Gold and Federal Reserve’s Interest Rates Decision

On March 18, the Federal Reserve provided guidance on what it will do regarding interest rates. It is adamant that interest rates will rise. Fourteen members of the Federal Open Market Committee (FOMC) believed that the federal funds rate will be at or above 0.625% in 2015, up from the current rate of 0.25%. For 2016, 15 members believed that rates will go up to 1.625% or higher. All members believed that by 2017, the key lending rate will be at or above two percent. (Source: Board of Governors of the Federal Reserve System web site, last accessed March 23, 2015.)

For one second, let’s assume that the Federal Reserve will follow this pattern. If it raises interest rates to 0.625% by the end of 2015, then it will mean an increase of 150% from the current level. In 2016, if the Federal Reserve moves rates to 1.625%, that will mean an increase of 550% from the current level. Finally, if the key rate rises to two percent by 2017, it would mean an increase of 700% from current levels.

Looking at this, I am asking if the U.S. economy will be able to handle these rate moves.

While many will argue that the Federal Reserve increasing its benchmark interest rates is bearish for gold, I am thinking the complete opposite. I believe that as interest rates move, there will be a lot of uncertainty. Since the Great Recession, investors have become too addicted to low interest rates. They will have difficulty adjusting their portfolio. As a result, there will be a shift towards gold.

U.S. Dollar Losing Its Lust Positive for Precious Metals

The other factor I am watching closely, the U.S. dollar is losing its fame very quickly.

Over the past few months, the biggest factor blamed for the lower gold prices has been the rising U.S. dollar. Since June of 2014, the U.S. dollar index (which compares the U.S. dollar to a basket of major global currencies) has increased a little more than 20%.

I am questioning if this rally in the greenback will continue over the long-term.

You see, as it stands, the anti-dollar movement is gaining momentum. Consider this: China is in the midst of forming the Asian Infrastructure Investment Bank, or AIIB for short. This bank is similar to the International Monetary Fund (IMF) and the World Bank—two institutions that are U.S. dollar-dominated and largely influenced by the U.S. government. Other than this, over the past one year, we also have seen countries signing agreements to trade in their own currencies, rather than the U.S. dollar.

Understand this: these are all early signs that the U.S. dollar is losing its popularity. If this continues—and I don’t doubt for a second it won’t—it will only be good for gold, as the precious metal rises when the greenback depreciates.

Time to Buy Gold?

I reiterate my take on this topic: I am thinking long-term when I look at gold. I am not concerned about what happens tomorrow or even a month from now. In the short-term, I won’t be surprised to see the precious metal’s prices decline even further. But, in my opinion, the downside will not be as big.

Over the long-term, I believe the yellow metal definitely has room to go much higher. As I see it, the highs made in 2011 shouldn’t be ruled out just yet.