Why a June Rate Hike Could Crash Gold Stocks

When it comes to financial markets, always prepare for the unexpected.

Making money isn’t simple. You can’t just buy gold stocks, hope for the best, and expect them to rise forever. If this were the case, I’d be out of a job.

In reality, financial markets are volatile, and sentiment changes quickly. When a big change happens, markets move sharply. This leaves plenty of punters buying the high, assuming the direction is locked and loaded forever.

In December, the US Fed said it would raise rates four times in 2016. This spooked the markets, sending gold and stocks crashing. The entire world looked as if it was falling apart at the seams, ushering in the first major stock market correction in years.

Fed officials got scared and back flipped on their policy. In February, they announced rates would rise only twice this year. Gold and stocks rocketed higher. But should we believe them?

Who knows. I don’t think they even believe themselves.

Jokes aside, I expect the Fed to raise rates this year. In fact, contrary to popular opinion, the first rate hike could be in June. If this happens, gold stocks are likely to start crashing soon.

I’ll explain…

The Fed has no end game

I realise I’m in the minority. But, with an open mind, I’m convinced I’m right.

Putting aside the idea of gold crashing for the moment, most punters believe the Fed won’t raise rates this year again. Or, perhaps, ever again…

I’m not just talking about mainstream analysts…

I’m an outsider at our contrarian company, Port Phillip Publishing. Most of my colleagues believe rates won’t go higher, and that gold’s set for new highs.

Greg Canavan, Editor of Crisis & Opportunity, talks about both topics frequently. Greg’s an excellent analyst, having picked some big winners for his readers this year. In Greg’s view, the gold bull market is underway. Understandably, seeing gold pop higher this year, Greg’s gold stock picks have done quite nicely so far.

Unfortunately, while I’d like to join the bull club, I just can’t agree. There are plenty of bearish arguments for gold. However, let’s just focus on the Fed today. In my view, like many others, the Fed is trapped. But, unlike many others, I feel it has no other choice BUT to raise rates.

On this topic, the recent presentation at the Sohn Conference in New York is gaining a lot of airplay. You may have read it yourself. It’s titled ‘The Endgame’, by Stanley Druckenmiller.

Druckenmiller isn’t confident about the future — at all. To sum up a long read, he’s a huge gold bull, and a massive stock market bear.

Keep in mind, Druckenmiller isn’t some kind of permabear. He isn’t Peter Schiff, CEO and Chief Global Strategist of Euro Pacific Capital. Or Marc Faber, Editor of The Gloom and Doom Report. His investment record speaks for itself (30% average annual return from 1986–2010). On this note, just in case you haven’t read the report, take a look at the best parts:

When I started Duquesne in February of 1981, the risk free rate of return, 5 year treasuries, was 15%. Real rates were close to 5%. We were setting up for one of the greatest bull markets in financial history as assets were priced incredibly cheaply to compete with risk free rates and Volcker’s brutal monetary squeeze forced much needed restructuring at the macro and micro level.

During the great recession, rates were set at zero and they expanded their balance sheet by $1.4T. More to the point, after the great recession ended, the Fed continued to expand their balance sheet another $2.2T. Today, with unemployment below 5% and inflation close to 2%, the Fed’s radical dovishness continues.

If the Fed was using an average of Volcker and Greenspan’s response to data as implied by standard Taylor rules, Fed Funds would be close to 3% today. In other words, and quite ironically, this is the least “data dependent” Fed we have had in history.

Indeed, Druckenmiller hit the proverbial nail on the head. This is the least ‘data dependent’ Fed we’ve had in history.

The US Fed Chairperson, Janet Yellen, wants to raise rates drastically. She realises that another financial meltdown is inevitable. When it hits, Yellen needs higher rates to handle the crisis. Without it, the Fed is pretty much…well…useless.

For this reason, Yellen’s tried to hike rates numerous times in the past year. Unfortunately, it’s not that simple. See, the US dollar is the world’s reserve currency. Yellen knows, if she hikes rates, the dollar will go through the roof. If this happens, it will bankrupt much of the world, eventually bringing domestic profits to a halt.

In other words, the US Fed can handle a rate rise. But the rest of the world can’t. Yellen is more worried about international problems than she is about domestic issues.

The Fed rate hikes are coming

Unfortunately, Yellen’s backed herself into a corner — and not because of poor economic numbers. Druckenmiller elaborates:

The obsession with short-term stimuli contrasts with the structural reform mindset back in the early 80s. Volcker was willing to sacrifice near term pain to rid the economy of inflation and drive reform. The turbulence he engineered led to a productivity boom, a surge in real growth, and a 25 year bull market. 

The Fed has no end game. The Fed’s objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term. In doing so, they are enabling the opposite of needed reform and increasing, not lowering, the odds of the economic tail risk they are trying to avoid. 

Indeed, international markets are hooked on central banking monetary easing. The majority of punters, politicians and mainstream commentators argue that a hike will crash the US economy.

It’s a ridiculous claim.

The US economy is the largest in the world. Druckenmiller, an equities bear and gold bull, admits the US economy is stable enough to handle a hike. He said the Federal Funds Rate should be at 3%. At this time, the Fed has adopted an interest rate range of 0.25% to 0.50%. There’s plenty of room left in the tank for higher rates.

That said, after Friday’s poor US non-farm payrolls numbers, most punters believe rates aren’t going up anytime soon. Of course, I disagree. According to MarketWatch over the weekend,

New York Fed President William Dudley on Friday said while the April job gain was “a touch softer” than people were expecting, he was not putting a lot of weight on the data.

In an interview with the New York Times, Dudley didn’t discuss June directly. But he said two rate hikes this year remained a “reasonable expectation.”

Dudley is a voting member of the Fed’s policy committee and is someone markets pay close attention to as he is seen as a close ally of Fed Chairwoman Janet Yellen.

I wouldn’t write off a June hike based on one data point. Although, reviewing this history, the Fed no longer appears to be ‘data dependent’. It appears to be doing its own thing. For this reason, what matters most is its next signal to the market. Will the Fed raise rates in June…or not?

The signal might not come until the end of the month. Remember, the Fed meeting is scheduled for 14–15 June. So there’s no urgency to rush a decision. There’s plenty of data, which the Fed claims to be watching, due out soon. Retail sales is an important variable.

If the Fed announces that it’s looking to hike, sentiment will change. The stock market, nor gold, is ready for a change in sentiment. Are you?

This is one reason, of many, why I’ve avoided recommending gold producers to Resource Speculator readers. There will be a better time to buy. If you want to know when, check out Resource Speculator here.


Jason Stevenson,
Resources Analyst, Money Morning

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia