Remember last year when some people were saying that gold prices would crash because the U.S. Federal Reserve would raise interest rates? Well, they couldn’t be more wrong. Since December 16, 2015—the date of the first Fed rate hike since the financial crisis—the gold spot price has surged 14.3%. Going forward, there are still quite a few catalysts that could send the price of the shiny metal even higher.
QE Coming Soon?
While several Fed people have been calling for more rate hikes, Fed Chair Janet Yellen thought otherwise. Speaking at the Economic Club in New York on Tuesday, Yellen said that the Federal Open Market Committee (FOMC) would “proceed cautiously” with interest rate policies, and that caution “is especially warranted.” (Source: “The Outlook, Uncertainty, and Monetary Policy,” Board of Governors of the Federal Reserve System, March 29, 2016.)
So, what would the Fed do?
According to Ray Dalio, founder of Bridgewater Associates, the largest hedge fund in the world, the Fed would do the opposite of a rate hike. In an interview with Bloomberg earlier last month, Dalio said that quantitative easing would be the Fed’s next big move. (Source: “Bridgewater’s Ray Dalio on Economy, Investing, Success,” Bloomberg, March 3, 2016.)
If the Fed is going towards quantitative easing (QE) instead of a big tightening, what should investors do? Well, according to the billionaire hedge fund manager, you should have some gold in your portfolio.
“I think that gold, at five percent of your portfolio, at ten percent of your portfolio, under the circumstances, would be also a prudent thing to do. Prudence is the important thing to do,” said Dalio. (Source: Ibid.)
When you think of QE, you can’t ignore its consequences. The Fed’s last three quantitative easing programs have poured huge amounts of fiat money into the economic system. Since the Great Recession started in 2008, the Fed has increased money supply by 67%, or more than $5.0 trillion!
Eventually, monetary inflation will translate to price inflation. The logic is simple: when more money is chasing the same basket of goods, each good in the basket is going to command a higher price.
If you are a borrower, you’d be fine under inflation because the amount you need to pay back in real terms is less than what you borrowed. However, if you are a lender/saver, you’d be in trouble.
You see, interest rates are pretty low. Factoring in inflation, the money in your savings account after a few years probably won’t be worth as much in real terms as before. So you are losing purchasing power by putting money into your savings accounts.
The fundamental reason behind this problem is that fiat money can be printed as much as the central banks want. Gold, on the other hand, cannot be created out of thin air. That’s why for thousands of years, gold has helped generations of people preserve their wealth.
Of course, central banks know about the fallacy in their fiat currencies. That’s why they have been hoarding the yellow metal. In the fourth quarter of 2015, central banks around the world bought a total of 167.2 tons of gold, representing a 25% increase year-over-year. Note that central banks have been net buyers of gold since 2010. (Source: “Gold Demand Trends Full Year 2015,” World Gold Council, February 2016.)
The Bottom Line on Gold Prices
There you have it. You don’t really need to think where gold prices are going next. Instead, ask yourself this: with the world economy being what it is today, can you afford not to look at the shiny metal?