The Fed Tapering Effects on Gold & Silver
When the minutes of the latest Federal Reserve (The Fed) Meeting was made public on Wednesday, the market reactions were swift. The Dow Jones Industrial Average (Dow) dropped 1.1%, while the tech-heavy Nasdaq Composite Index (Nasdaq) dropped 3.3% in the afternoon. Year to date, the Dow is down 3% and the Nasdaq is down 7%. The cryptocurrency, “Bitcoin,” followed the Nasdaq down 3.3% Wednesday and, as of January 10, is down 11% so far in 2022, making gold a relatively good performer so far this year, down 1%, with silver down 3%. Platinum is down 2% for the year, while palladium is currently up a fraction. However, the main story is what this news might mean throughout this and next year for the metals and the other sectors mentioned.
The most significant information revealed from the Fed minutes was that the schedule to “taper” would likely be moved up a few months, from June to March of 2022. Tapering refers to the series of bond purchases the Fed engaged in over the last couple of years, as they sought to smooth out some of the economic effects of the pandemic. But “tapering” only means that the rate of bond purchases will be reduced, not that the assets currently on the books will be sold off. In other words, someone else will have to step up to the plate to purchase US Treasury securities issued in the future, as the Fed expects to slow or stop their purchases. The Fed has purchased and is currently holding over $8.7 Trillion on their balance sheet, which has more than doubled in size over the last year.
Tapering Doesn’t Mean Selling
It would be far more damaging to the markets if the Fed were to try and liquidate the existing bonds in their portfolio. Even if they were to sell only enough assets to bring their balance sheet back to pre-pandemic levels, they would likely rock the markets. Since 2022 is a mid-term election year, I doubt they will choose to do much of that in the near future. But interest rates are likely to rise sooner rather than later, though likely not very much. Consensus estimates in the WSJ article linked in the above paragraph indicate rates may increase up to 0.75% by the end of the year. Hardly the 20.0% rates experienced under Fed Chairman Volcker back in the early 1980s, but hopefully enough to provide incentives for foreigners to purchase more US Treasuries.
One of the challenges mentioned in the Fed minutes was an inflationary environment that continues to persist, despite earlier estimations that inflation would be “transitory.” Part of the reason for stubborn inflation is product shortages due to delays unloading ships at the ports. Despite government announcements of fewer ships seen offshore near the ports on the West Coast, the number of delays has continued to increase. Instead of waiting near the shore where they can be seen, ships are now waiting further away - out of public view. As the graphic from the Marine Exchange of Southern California illustrates, the number of ships waiting to unload has continued to rise even after initiatives were announced about expanded hours at West Coast ports. Consequently, the delays continue, and prices have continued to rise.
Continued Funding Needs
The money supply has increased more rapidly during the pandemic than at any time in our history. With new stimulus measures considered by a few members of Congress, there is an ongoing demand for the government to borrow more funds by issuing more treasury securities. There was insufficient demand worldwide to purchase all of these securities at current interest rates, which is why the Fed purchased them. With tapering plans announced, it is hoped that the incremental interest rate increases will help entice other purchasers back into the US treasury market. An increase of 0.75% might not seem like a lot, but compared to what rates look like in Europe or Japan, it makes US debt more attractive on a relative basis.
Because the expected interest rate increases are far lower than what has proven useful to slow inflation in the past, I believe the inflationary environment recently experienced will likely continue. During the previous major stagflationary conditions, gold and silver performed well. It was only after interest rates were raised to 20%, that they began to have a significant correction. For this reason, I believe precious metals offers a relatively good opportunity for investors, in spite of the taper announcements recently released by the Fed.
Store of Value vs Store of Volatility
Precious metals are often described as a “store of value”, that can protect purchasing power over time and during difficult economic conditions such as we have today. Cryptocurrencies are more aptly described as a “store of speculation”, that has proven to be very volatile in the face of economic headwinds. National currencies could be described as a “store of devaluation”, as you generally lose purchasing power over time while holding it. Even with funds on deposit earning interest, unless you are depositing funds in Russia, you are likely earning negative real interest rates on those funds. It is commonly understood that existing bonds lose value when interest rates rise, making bonds more unattractive as an asset class. And equities continue to hover near record levels, making them an unacceptable risk for many.
For these and other reasons, gold, silver, and platinum provide a relatively safe alternative place to store some of your investments and retirement savings. With rising energy prices, the cost to mine and refine these metals is also going up. “All In Sustaining Cost” (AISC) is a measurement of how much it costs the mining industry (or a particular company) to break even when mining metals. That is, what price for gold or silver is needed to justify pulling them out of the ground. This price acts as a support level for the metals and indicates how much downside risk exists in owning them. Many analysts expect AISC amounts to increase in 2022-2023, making precious metals less risky to own.
In summary, the response of the metals to the Fed announcement on Wednesday has been muted, compared to other asset classes. The released news is more dangerous for stocks, cryptocurrency, bonds, and real estate, than it is for precious metals. Because the interest rate increases will not move rates into positive territory (relative to inflation), we will continue to see a negative-real-interest-rate environment that is bad for cash and good for gold.