Gold Surges as The Federal Reserve is Unlikely to Increase Interest Rates

• August 2, 2016

Gold prices are near multiyear highs. Source: MetalMiner analysis of @StockCharts.com data.

Gold prices surged last week, settling near multiyear highs. Two developments added fuel to gold’s bull market:

Weak GDP Data

For the second quarter, the U.S. gross domestic product grew at a seasonally adjusted annual rate of 1.2%, less than half the rate economists had predicted for the second quarter, casting doubt on the strength of the U.S. economic recovery. Gold benefited from safe-haven demand on a worsening economic outlook.

Meanwhile, Federal Reserve officials said earlier last week that they could raise rates as early as September, but most analysts agree that their language isn’t hawkish enough to suggest an increase is forthcoming.

In addition, the weak data raises even more doubts on whether the Fed will raise interest rates this year. Gold is a more attractive asset when interest rates are low. On the other hand, a rate hike would lower the value of gold, since investors would prefer to park their money in yield-bearing bonds than gold.

Japan Didn’t Ease Monetary Policy

The U.S. dollar index falls on weak GDP and a stronger Yen. Source: MetalMiner analysis of @StockCharts.com data.

The U.S. dollar fell sharply against the yen last week after the Central Bank of Japanannounced limited easing measures. Markets were surprised the Bank didn’t do more to ease monetary policy.

Expectations that the Fed would raise rates this year combined with easier monetary policy elsewhere would make the dollar more attractive to yield-seeking investors, but things are going the other way. The Fed is not raising rates and countries like Japan are not easing monetary policy as much as investors had expected. Consequently, the U.S. dollar has fallen, giving a boost to dollar-denominated assets such as gold.

What This Means For Gold Buyers

A more dismal economic outlook, a falling dollar and ongoing low interest rates in the U.S. continue to favor rising gold prices. Until we see any of these drivers turning around, we would expect gold’s (and silver’s) bull market to continue.